Bargaining Power: Host States and International Oil Companies

Bargaining Power: Host States and International Oil Companies
A Topical Overview
Oil is the most important natural resource of the industrialized nation (Wintershall 2014). It will likely continue to be this way until alternative energy sources become sufficiently robust to handle the energy needs of the human race. According to Wintershall (2014), “It can generate heat, drive machinery and fuel vehicles and airplanes. Its components are used to manufacture almost all chemical products, such as plastics, detergents, paints and even medicine” (p. 1). As a result, the importance of oil to the globalized marketplace cannot be understated. Due to its high demand and limited supply, the oil market is big business and the earnings of some IOCs annually are often times larger than those of the emergent nations where oil reserves can be found. Within the realms of IOCs and host states, both sides have power and respective advantages that can be used to gain influence over the other during negotiations. Depending on a variety of climate related dynamics, where the highest degree of influence lies can fluctuate. There is no consensus over who has the greatest degree of influence in bargaining situations for oil exploration and production and considerable debate exists related to who should have the advantage. Most of these arguments are respective to a single stakeholder position and are by no means non partisan. In an effort to examine the complex paradigm of bargaining powers between hosts states and international oil companies, this work will take a non partisan look at all the available data to generate a balanced view of the entire situation. In doing so, sustainable long term producing, legal frameworks, resource nationalism and other dynamics will be considered.
Bargaining: Establishing a Definition
Before any involved discourse into the subject can manifest, a working definition of bargaining must first be established. According to the Business Dictionary (2014), “In negotiating, the capacity of one party to dominate the other due to its influence, power, size or status, or through a combination of different persuasion tactics” defines bargaining power (p. 1). The definition of bargaining power and how the parameters are established can be influenced by economic and legal factors thereby not making it static (Dau-Schmidt & Ellis, 2011). While in the best case scenarios, bargaining leads to arrangements that are win-win for both parties, the reality of the situation is that often times one side gains an advantage over the other. Many people and entities entering into bargaining arrangements are seeking to gain an advantage. Business, in this capacity, is not fully cooperative. For IOCs, they are looking for maximum return on investment and for host states, they are looking for maximum benefit and control. For IOCs, they are often at the mercy of their shareholders and for host nations, they are at the mercy of their constituents. As will be illustrated in both situations, each can influence how oil/resource relationships develop. According to Oil Uganda (2014),
Most economists, however, would still insist that it all comes down to economic incentives. If an oil (or energy) company can drive a bargain on highly favorable terms, it will. Some people calls this cheating. Others just call it business (p. 1).

These perceptions are important in the bargaining process and weigh heavily on how power can be distributed at any given time.
Examining Power Holder Positions
To establish the two different sides of the bargaining equation, it is necessary to understand how these situations benefit both parties. For host governments, they aim to transfer economic rent from foreign investors (Vivoda, 2014; Globerman & Shapiro, 1998). They attempt to do this without reducing the inflow of beneficial foreign investment (Vivoda, 2014). Conflicts between the government hosts and external investment usually center on how rents are divided (Vivoda, 2014). Both parties see their potential risks as being greater than the others and therefore they bargain with a spirited belief in that perspective. Oil companies, however, are businesses and like any other type of business, they exist to make profit for their shareholders (Oil, 2014). The less they have to pay in terms of production is equitable to more profit. This can be considered the classic Marxist (1910) style critique of capitalism. In the most rudimentary of terms, labor, environmental protections and other various elements that are important to host nations are simply “expenses” to oil companies that limit potential for profit. Though oil companies have done a great deal to attempt to clean up their image to the world, most people still generally distrust big oil and they feel that these campaigns to demonstrate global responsibility are nothing more than clever PR (Oil, 2014).
At the present time, there remains general distrust between IOCs and host states and they both have strong foundations for such concerns. For IOCs, they are risking a great deal in terms of long term investment. Elements like political instability, particularly in emergent economies, governments reneging on contracts and the fact that it may take years to get any ROI are very legitimate risks they take (Oil 2014). To them, the profound nature of these risks is enough to rationalize the high returns in which they can generate when business matters work out properly. During the exploratory phases or preliminary phases of negotiating, often times “what if” situations are part of the legal process. When the IOCs begin exploring, there are no guarantees as to what they will find or the degree to which resources will be accessible. Host nations and IOCs often enter into agreements based on the premise that something may be found. If something is not found, the IOCs will lose their exploratory investment with no return. If something is found, in good faith they have to trust that government will honor its arrangements and allow them to set up shop so they can get ROI on their exploratory efforts. This is very risky for IOCs as when resource nationalism comes into play, there are few guarantees.
Cross border disputes necessitate world economic court and this necessitates that both parties will abide by rulings. In the case of rogue governments or states, such rulings are merely tongue and cheek. There is a strong propensity for internal unrest to be blamed on external foes throughout human history (Keegan 1995). Oil resource disputes is no exception to this rule. When host nations, either pushed by the pressure of the people or by new governments begin to look at outside investors as being exploitative, they often times react harshly. If an IOC signed an agreement with a previous government, a new government in power may not recognize that agreement as having any value and that could mean that the IOC simply would have to leave the region. People can revolt and when they do, this is detrimental to outside investment. This phenomenon has been seen in the Nigerian Delta or in the populist governments of Venezuela or Bolivia (Stevens 2014). In all cases, however, it is the IOC that incurs the risks associated with political instability and these risks are quite large and very real.
Reference in the previous discussion was made to resource nationalism. This concepts is strong starting point for analyzing the perspectives and risks related to host nations. Resource nationalism is defined by Stevens (2014) as “Limiting the operations of private international oil companies and asserting greater national control over natural resource development” (p. 5). Classic examples of resource nationalism being the rule rather than the exception are Canada and Australia (Stevens 2014). Depending on one’s perspective, this is either a logical response to outside “investors” who are only seeking to profit from the region thereby making it an necessary protective element or it is simply a hindrance to globalization (free market economics). For host nations, like the risks associated with investing, there are legitimate concerns. There is currently what can be considered a perception among common people that they get no benefit from outside investment (Stevens 2014). They see outside companies profiting from their resources and they question what gain their is for them. Of course, these IOCs are paying taxes to their governments and keeping up their part of the agreement (Stevens 2014). While this may be true, there is considerable criticism that can be waged on the concept of trickle down economics.
Trickle down economics is the main rationale of neoliberal globalization (Hertz 2002). Economist and social critic, Hertz (2002), believes that the perspective of the resource nationalists has validity being that trickle down is “An illusion. Special interests have gained in power. Some have voice, but many remain voiceless. What arises from patters of exclusion is a deep and growing chasm between the global economy and social justice” (p. 35). In essence, if the perspective of Hertz (2002) is accepted, the people seeking to protect their resources from outside plundering would be wise as they are not actually going to see much benefit from this at all. While this position is open to debate and controversial, what is less controversial is the environmental factors related to IOCs. Most major oil companies have been associated with at least one catastrophic environmental pollution (Oil 2014). The environmental risk is holistically incurred by the host state. This factor alone is considered by many host states to be enough to demonstrate that the host state should get the lion’s share of the profit. When environmental risk happens, the host state can face dire economic consequence. In the US, when British Petroleum (BP) facilitated the Gulf oil spill, the entire Gulf of Mexico Industry among the Gulf Coast states was crippled and the full cost of the disaster and cleanup will never be equitable to the profits made by allowing the oil giant to drill there.
Accessing the Advantage
There are spirited arguments on both sides of the debate that suggest that either side has advantages over the other when it comes to bargaining. In reality, both sides of the equation are correct, however, they are not correct all of the time. There are factors that can tip the scales in favor of one’s strength over the other at given points in time. Before these factors are highlighted in cycles, the innate advantages of both sides of the bargaining equation have to be established. For IOCs, the primary advantage is the power they hold as a result of how much money they have. For example, the French company TOTAL, had a 209 billion dollar revenue and profits of 13.9 billion US dollars (Oil 2014). Uganda, an emergent host state, in contrast, only generated 2.7 billion dollars when all of the nation’s industries were considered (Oil 2014). The extra money generated by the oil companies gives them access to the best lawyers, accountants and consultants and critics have pointed out that this gives them a profound advantage when negotiating deals (Oil 2014). Expertise is a known advantage in the business world (Acona, 2005). The resources at the disposal of big oil puts them far ahead of most developing host nations. There are many situations, as a result, where IOCs walk away from bargaining situations with very large profits for their company.
Others would argue that it is the host state who holds all the power. It is the host state who will set labor, safety and environmental standards that the IOCs will have to adhere by. The IOCs cannot change labor laws or existing safety dimensions that may be unique to that area. In addition, these regulations can change without warning and IOCs would be forced to comply. At any point in time, if the IOC does not comply, they can be forced to leave. All interpretive paradigms of operation are based on the host state. When host states are unstable, as they often are in emergent economies, the way they deal with outsiders can fluctuate annually. In the end, the IOC needs the host state but the host state does not necessarily need the IOC. If the IOC does not have an oil supply, they cannot be profitable. Since the host state can determine whether or not they will allow the IOC to come and explore or cultivate resources, this is a considerable source of power that some would say eclipses the the financial expertise advantages afforded by the profitability of oil companies.
Looking at how these strengths have manifested throughout recent history can demonstrate the way in which these elements influence in practice. In the 1970’s, the early 1980’s and the 2000’s, the relationships between host states and IOCs can best be classified as conflicting (Vivoda 2014). At these points in time, high oil prices gave the host states more capital so the could re-negotiate the agreements with the IOCs so they could gain higher shares of the economic rent (Vivoda 2014). These periods demonstrated a low degree of compatibility between host states and IOC interests (Vivoda 2014). In this situation, the host states were able to use their strengths to gain bargaining power over the IOCs. In the late 1980’s and the 1900’s, this situation changed however. These periods can be characterized as cooperative in nature. Falling markets and low prices resulted in the balance of power shifting toward the IOCs, which allowed them to get stronger investment terms in oil exporting countries (Vivoda 2014). The IOC and host state situation is very volatile and this makes this industry quite different from other global financial endeavors. Since 1986, it can be stated that crude oil, refined petroleum and natural gas prices have been more volatile than 95% of other producer price index commodities (Vivoda 2014; Regnier 2007).
The best way to understand this relationship and the way in which leverage is gained is by looking at supply and demand in rudimentary economic analysis. When a market rises, ie, the demand for a product, the sellers gain leverage. The sellers in this particular situation would be the oil exporting governments or the host states (Vivoda 2014). These would be the situations that were aforementioned to be present in the 1970’s, the early 1980’s and the 2000’s (Vivoda, 2014). When the market falls and the demand gets lower, the buyers gain an advantage. The buyers would be IOCs or oil importing governments (Vivoda 2014). This was the type of relationship that manifested during the late 1980’s and through the 1990’s (Vivoda 2014). Vivoda (2014) demonstrates the unique nature of this for developing emergent economies from host states. He explained, “In times of rising prices, the governments of developing states, which occupy a subordinate position in the international system, have real incentive to alter the basic rules of the game and reverse this status quo” (p. 2). There is a reverse side to this equation in regards to host nations.
Not all host nations are created equal in terms of IOC agreement risks. In this capacity, a host nation that is economically and politically stable with strong legal frameworks for enforcing contracts would have less related risks for IOCs. In addition, these larger economies may hold higher advantages because of their stability and the fact that they may need external investment less than emergent economies. As a result, host nations cannot simply be lumped into a single conglomerate with static strengths and weaknesses in bargaining. The way in which the strengths and weaknesses manifest is largely a product of where the host nation is politically and economically. For example, there may be lower risks for a big oil company working with the United States as a host nation that gives the host state an advantage in the bargaining paradigm. On the other end of this spectrum, a nation like Uganda would have many associated risks for IOCs that could give them a bargaining advantage in terms of how much risk they are potentially incurring as a result of the number of unknown variables.
Conclusions
The bargaining power between host states and international oil companies is best characterized as being complex. Payments, concessions, returns, political stability, expertise, unknown factors, demand, price and a nearly infinite number of factors work together to influence who will have the bulk of the power in any given situation. Both sides of this equation have valid reasons to be concerned about the motivations and track records of the other. Both sides naturally will incur risks associated with these relationships. It is the supply and demand dimensions, however, that hold the bulk of the pendulum sway when it comes to bargaining power negotiations as can be illustrated through the economic periods from the 1970’s until the present time.
















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