How to Negotiate the „Right‟
Mining Agreement
BY
JENIK RADON
COLUMBIA UNIVERSITY
Background
Done right, natural resource extraction can be a
boon for social and economic development
Success stories of Botswana, Chile and Norway
Negotiating the right contract is vital to a
government‟s effort to reap the benefits of its natural
resources.
How governments can develop
their resources
1. STATE COMPANIES, E.G. SAUDI ARABIA,
BRAZIL (SEMI)
2. PRIVATE INTERNATIONAL MAJORS, E.G.
US, CANADA, UK,
3. COMBINATION OF 1 & 2, E.G. NIGERIA,
AZERBAIJAN, KAZAKHSTAN
Legal and Regulatory Approaches to Resource
Exploitation
Many developed countries use unilateral
licensing/leasing approach
Many developing countries use consensual approach
and prefer mining agreements
Political will of host country to develop resources is
key and expressed through regulatory instruments,
by contractual means, national policies and
guidelines
How Mining Companies determine a host
country‟s political will
First policy instrument to be consulted is Mining
Code (MC):
MC addresses core issue of mineral exploration and
exploitation rights such as property rights and form of
agreements
MC has the force of law as opposed to „soft‟ guidelines
Majority of countries have MCs (E.g. Australia, Botswana,
Brazil, Chile, Indonesia, Papua New Guinea)
Caveat: MC can be outdated and therefore does not represent
present political will any more
Mining Codes
There is not a „one-size-fits-all‟ MC
MC must consider the economic, historical,
sociological, administrative and political setting of a
specific country
MC must balance host country‟s interests with
mining companies‟ concerns
Mining Agreements
May be used instead of or in addition to M
Mining Agreements may be defined as: Agreement
between a nation-state and a private entity about the
development of resources and the production,
processing, transportation, and marketing of goods
from resources.
Address issues absent in MC
Reassure foreign investors
Why do contracts matter?
Contract terms determine
(1) how much a producing country
earns from it natural resources;
(2) the regulatory power of
government to enforce environmental,
health and other standards, if legal
and regulatory system not well
established
Key Issues of all Mining Agreements
How profits are divided between government and
participating companies
How costs are treated, expensed or depreciated
What to treat as costs, e.g. Expat housing, best technology
Taxes, royalties, excess profit taxes
Stabilization, what kind
Timing
Uncertainty about development and exploration costs
complicates negotiations
abandonment
Balance needed between country‟s and investor‟s interests
Takes into consideration the communities or entities not party
to the deal but who will be interested or affected by it
Contractual Systems
To achieve such balance of country and investor
interests the choice of contractual system is crucial
4 basic contracts:
Concession or license agreement
Joint venture (JV)
Production-sharing agreement (PSA)
Service Agreement
The four basic contractual
provisions
•C O N C E S S I O N O R L I C E N S E A G R E E M E N T
• JOINT VENTURE (JV)
• PRODUCTION-SHARING AGREEMENT (PSA)
• SERVICE AGREEMENT
Bilateral Agreement v.
Unilateral Permit
SHOULD GOVERNMENTS RELY ON MINERAL
AGREEMENTS, PERMITS BASED ON THE
MINING CODE OR ON A HYBRID SYSTEM?
Concession or License
Agreements
GRANT MINING COMPANY
EXCLUSIVE RIGHTS TO EXPLORE,
DEVELOP, SELL, AND EXPORT
NATURAL RESOURCES FROM A
SPECIFIED AREA FOR A FIXED
PERIOD OF TIME
Different Ways of Granting Mineral Exploitation
Rights
Licensing system based on MC and national
regulation
Systematic use of MAs which complete the national
MC
Hybrid system where national regulations and MAs
both apply
Australian Licensing System
Combines contractual and legislative tools
Creation of a right to explore or mine is subject to
licensing by federal and territory governments
Governments own the minerals
Special negotiating rights granted to Aborigines in
areas where they hold a claim or interest in the land
Government ad hoc agreements are justified by the
idea that the state mining acts are inadequate to
accommodate large-scale mineral projects
Australian Licensing System
Advantages Disadvantages
Provides government
with a means of
coordinating regulatory
controls and create
unique legal regime for
each project
Provides opportunity to
maximize local industry
participation
Require TMC to develop
infrastructure
Australian Licensing System
Advantages Disadvantages
Provides TMC with Expensive and time
high level of protection consuming
from arbitrary High degree of
government action complexity
Overrides MC and can
undermine rule of law
(„one-off‟ law)
Chilean Licensing System (Hybrid)
Hard minerals are exploited under a concession
regime
Grant of mineral rights through legislative provisions
Separate grant of authorization to invest in mining
project to foreign investors
Mineral ownership is transferred by the state to the
miner
Mining concession issued by courts to first petitioner
Chilean Licensing System
Advantages Disadvantages
Impartiality of body First-come-first-serve
granting the concession approach may not
favor most efficient or
profitable bidder
Indonesian Licensing System
Mineral rights licensing system regarding the TMCs
is essentially provided for in model mining
agreements: the Contract of Work
Government ownership of minerals which cannot be
transferred to TMC
Under Mining Law Minister of Mines can designate
other parties to carry out mining operations as
contractors for the government or state companies
Indonesian Licensing System
A Contract of Work (COW) is a model agreement
issued by the state, within which the foreign
company is given right to operate as a concession
holder, but for and on behalf of the government
Mining authorization is just a permit to undertake
the mining activity. The holder of such a mining
authority has always to observe the prevailing laws
and regulations
Papua New Guinea Licensing System
Small and medium-scale mining projects regulated
by MC
Mining agreements for major projects
Mineral resources are owned by the state
Ming agreements are not enacted into law anymore
to allow for changes, ease renegotiation, and ensure
confidentiality
Mining Agreements
IN THE ABSENCE OF A MODERN REGULATORY
FRAMEWORK MA IS AN APPROPRIATE VEHICLE
TO EXPRESS POLITICAL WILL
MA CAN FILL GAPS IN MC
ALLOW GOVERNMENTS TO EXPRESS THEIR
CURRENT POSITION AS OPPOSED TO OUTDATED
MC
A SINGLE MA CAN REPLACE A MULTIPLICITY OF
PERMITS AND ADMINISTRATIVE
AUTHORIZATIONS
GIVES INVESTOR MORE CONFIDENCE IN
STABILITY OF THEIR RIGHTS
ISSUES WHICH ARE TOUCHED UPON SUCH AS
INDIGENOUS AND ENVIRONMENTAL RIGHTS CAN
BE INCLUDED
Hybrid System
Provided that a modern and comprehensive MC exists, a
system where a permit is based on the MC may work best
Avoids „one-off‟ agreements and provides consistency
and certainty
MA requires expertise and negotiation skills which
cannot be found everywhere
MA can fill voids of MC
Co-existence of MA and MC allows to tailor permit to
project characteristics.
Clear delineation between MA and MC and their
relationship needed
Different Types of MA
SERVICE CONTRACT
PRODUCTION-SHARING AGREEMENT
JOINT VENTURE
THE KEY FACTOR THAT DIFFERENTIATES ALL
OF THE ABOVE FROM COLONIAL CONCESSION
SYSTEM IS THE CONTROL AND OWNERSHIP
BY THE STATE IN THE MINING VENTURE
Concession or License Agreements
Advantages Disadvantages
If production occurs, Risk that government
government earns will not realize full
royalties based on potential from auction
gross revenue and/or system
profit tax based on net
income; both are based
on the quantity
produced and the price
at which commodity is
sold
Joint Ventures
•N O S I N G L E D E F I N I T I O N ; H I G H L Y F L E X I B L E
TOOL
• 2 OR MORE PARTIES WISH TO PURSUE A JOINT
UNDERTAKING IN SOME STILL TO BE CLARIFIED
FORM
• LOW SUCCESS RATE; LESS COMMONLY USED
• INDONESIA: JV BETWEEN RIGHTS HOLDER AND
TMC (LESS COMMON THAN CONTRACT OF WORK)
• AS NAME IMPLIES, IN JV THINGS ARE DONE
JOINTLY; THEREFORE, MATERIAL ISSUES NEED
TO BE RESOLVED PRIOR TO ENTERING INTO A
JV; REQUIRE LONG NEGOTIATIONS TO ENSURE
THAT ALL MATTERS ARE THOUGHTFULLY
ADDRESSED.
Joint Ventures
Cooperation between investor and host country
State and mining company share equity
Partners share losses and profits in proportion to
their participation in the mining venture
The owner of the mining title, installation and
production may be the host country or the mining
company, depending on the agreement
Joint Ventures
Advantages Disadvantages
Government is not alone Risks and costs are also
in the decision-making shared
and responsibility for a Responsibility also brings
with it potential liability,
project incl. for environmental
Government can count damage
on expertise of oil JV is inherently ambiguous
company and can complicate
negotiations which tend to
Government shares be lengthy; require more
profit, on top of taxes or legal advice than any other
royalties agreement
Joint Venture Characteristics
Pure JV Typical JV Full carry JV Former Soviet Union type JV
All costs/risks Government Government carried Government carried through
Shared carried through through exploration and rehabilitation and development
Exploration development until cash flow from operations
NOC←------------------------------------------------------------------------------------------------→IOC
Risk sharing
Service Contracts
Service Contracts
Mining company conducts mining activities on
behalf of the government
Key characteristics
Contractor works under government‟s mandate and is paid for
its work
Government maintains ownership and title of minerals
Contractor performs part or the whole of services needed for
mineral exploration and exploitation
Government is intended to provide the whole financing for the
service it contracts out
Production-Sharing
Agreements
FIRST USED BY INDONESIA IN 1966 AFTER
INDEPENDENCE TO REPLACE OLD COLONIAL LAW
(“LICENSE CONCESSION”)
BASIC CONCEPT: STATE RETAINS OWNERSHIP OF
NATURAL RESOURCES AND NEGOTIATES PROFIT -
SHARING SYSTEM
NOW COMMON FORM OF AGREEMENT, ESPECIALLY
IN CENTRAL ASIA AND THE CAUCASUS
PSA RECOGNIZES THAT THE OWNERSHIP OF THE
NATURAL RESOURCES REST WITH THE STATE BUT
AT THE SAME TIME PERMITS FOREIGN
CORPORATIONS TO MANAGE AND OPERATE THE
DEVELOPMENT OF THE OIL FIELD.
MINING COMPANY CARRIES MOST FINANCIAL
RISKS OF EXPLORATION AND DEVELOPMENT
OFTEN GOVERNMENTS CONTRIBUTE TO THE
SHARE CAPITAL OF THE CONSORTIUM
Production-Sharing
Agreements
EXACT SPLIT OF SHARES IS THE RESULT OF HARD
BARGAINING
FINANCIAL TERMS: HOST GOVERNMENT OFTEN EARNS
SIGNING BONUS, REGULARLY WAIVED FOR A GREATER
SHARE OF FUTURE PROFITS; OIL COMPANY IS FIRST
ENTITLED TO COST RECOVERY ; DEFINITIONAL PROBLEMS
OF WHAT IS A CAPITAL COST.
WHAT REMAINS IS SHARED ACCORDING TO THE AGREED
PERCENTAGE DIVISION WITH THE HOST GOVERNMENT.
FOREIGN COMPANY IS REQUIRED TO PAY TAXES BUT OFTEN
WAIVED AND INCLUDED IN THE COMPANY’S PORTION OF
THE AGREED PERCENTAGE SPLIT.
PSA ARE RARE IN MINING BECAUSE GOVERNMENT DOES NOT
HAVE A MAJOR INTEREST IN RECEIVING THE ACTUAL
PRODUCTION OF MINING ACTIVITIES AS IT HAS IN
PETROLEUM
Production-Sharing Agreements
Advantages Disadvantages
Government shares Government generally has
less knowledge about
potential profits without potential of oil field than
having to make a direct oil company
investment If government holds
significant share, it will
PSA can be enacted into face conflict of interest: it
law to provide legal has to balance the desire
security (Azerbaijan and for higher profits with the
enforcement of
other former Soviet environmental and other
republics) regulations
Production-Sharing Agreements
Advantages Disadvantages
PSA grants oil companies a
say in environmental and
other standards when these
standards have been
incorporated as contractual
provisions; violating a
contractual provision is
less costly than violation of
a regulation because only
in case of a serious or
material breach of contract
is the termination of the
agreement a possibility
Production-Sharing Agreements
Advantages Disadvantages
Violation of a legal statute
is an offense, subjective to
legislatively approved
sanctions and penalties
Making contracts into law
creates a legal
infrastructure of
exceptional situations;
little possibility of
developing a coherent and
comprehensive legal
system
Production-Sharing Agreements
Advantages Disadvantages
PSA positive legal
discrimination for oil
companies; investors
in other sectors will
invariably lobby the
host government for
similar special
treatment
Contractual Provisions
COMMON PROVISIONS FOR CONCESSION OR
LICENSE AGREEMENTS AND PRODUCTION-
SHARING AGREEMENTS
Parties
Host government should not assume contractual liability
as a direct party to an agreement to avoid direct
responsibility and unlimited liability
Instead, it should engage a state-owned enterprise as a
separate legal entity as contractual partner to limit its
liability; in case of liability only the enterprise‟s assets
can be seized
Mining companies usually create local subsidiaries with
limited or no assets of their own
Government should require guarantee from parent
company so it can tap into its resources to cover potential
liabilities
Accounting Methods
To determine profits, there must be a decision on
accounting methodology
Still no international accounting principles; only
national standards
Accounting standards leave room for discretion and
can lead to serious disputes; e.g. they don‟t have
provisions prohibiting any particular type of
expenses; clarification in contract needed
Accounting standards do not provide resolution for
intercompany pricing, which can inflate costs and
decrease government compensation
Recovery of Costs
How companies account for their costs determines
the taxes companies pay and the royalties they share
with governments
2 types of costs
Current operating costs: expensed in the year in which they are
incurred; immediate reduction in taxable profits
Capital investment costs: long term and can be depreciated
over a set period of time: quick depreciation means less profits
and decreases incentives to continue operations
Recovery of Costs
Depreciation period is important: Companies will
want to make up this investment as soon as possible.
There are a number of dangers if this is allowed to
occur:
Companies will have less to lose if project fails or discontinues
Profits for the year will be low
Government will receive lower returns on its tax or profit
sharing terms
Taxation or Compensation
Taxation of production matters because income from
oil production often accounts for biggest portion of
government budget
Profit tax
Can come in form of corporate income tax or as part of the
amount government agrees to take from any profits
Tax inspectors need to collect production and sales data and
audit company expenses
Problem of transfer pricing: oil sold to subsidiaries may be
priced above or below market price
Taxation or Compensation
Royalty or excise tax which is normally a percentage
of the value of the production
Often imposed on top of other taxes
Easy to administer
Can be inefficient, however, because they tax production
without regard to profit; when project is marginal, excise tax
may discourage further investment
Bonuses
Signature bonus: one-time payment before exploration starts
Production bonus: continued fixed payments
Bonuses are fixed payments and do not take profitability of
project into account
Service Agreement
SIMPLE: Payment for services, effectively set fee
CHALLENGE: Most energy companies reluctant to
sell services and/or technology know-how as earning
more limited
Environment
Government must have objective standards for environmental
protection and must not lower them in the hope of increasing
profits
When environmental standards are covered by contractual
agreements, oil companies can interpret, negotiate, or even
veto environmental standards
No reason why environmental standards should be lower in
developing countries considering that oil and gas are in such
high demand
Governments must take into account that companies prefer to
pay relatively low noncompliance penalties over investments
in pollution control
Fines should be high enough to act as deterrent
Restoration of polluted area by companies should be mandatory
Work Program
A work program details a company‟s exploration or
development plan
Companies tend to slow down projects they deem too
expensive
Governments should insist on a work plan that
specifies clearly the circumstances under which a
project could be delayed or discontinued
Stabilization
Stabilization provisions protect oil companies from
the cost of governmental or legislative changes
affecting contract terms during life of agreement
Stabilization provisions are extremely
disadvantageous for governments because it freezes
the legal and regulatory situation of the country for
an extended period of time (“Contractual
Colonialism”)
Variation clause/Renegotiation preferable if
circumstances change substantially
Arbitration
Arbitration clauses provide for the settlement of
conflicts between host country and mining company
by an arbitration court
Types of disputes need to be clearly defined in MA
Institutional or ad hoc
Price
Method of determining market price is critical as it
directly impacts compensation of government
A contract should specify what prices serve as
benchmark (e.g. price established by spot market in
the particular region)
Governments should never accept as contract price
the price paid between related companies; this price
is likely to be well below market price
Termination
Considering the significant amount of investment,
the mining agreement needs to address under what
circumstances it can be terminated
Examples:
Repeated and/or severe environmental violations
If companies no longer develop the mine
Other questions:
Ownership of mine after termination
Can government pursue other developing companies?
Outside Experts
Inevitable and necessary since government officials
cannot possibly know, understand or supervise every
of complex natural resource development process
Governments have to ensure that foreign experts
who negotiate contracts are truly independent
Outside experts must be evaluated, selected, then
managed and directed
Avoiding conflict of interests + ensuring trust are
KEY factors
Governing Law
Commonly chosen jurisdictions are the U.S. and the
U.K. or continental European jurisdictions such as
Switzerland
Regulatory authority must be retained by the host
country, i.e. under no circumstances should a foreign
law become the valid law of the host nation: this
would violate state sovereignty
Government may have to give assurances that laws
are stable
Transparency
Mining Agreements are complex and can be subject
to abuse and corruption
Transparency will prevent governments from
agreeing to terms the public cannot accept
To avoid corruption all contractual systems and most
terms should be disclosed; no need for full
confidentiality.
Contract transparency is key to curb corruption
“biggest obstacle to social and economic
development” (World Bank)