It is common practice for oil and gas producing countries to negotiate local content agreements with interested IOCs in an attempt to secure for the country a higher share of the value from oil and gas projects. This trend has surfaced as a result of the realization of the poor economic performance of many resource rich countries despite their vast wealth.
In recognition of this, the IMF in September 2007 put out a working paper 'to offer specific inputs to the debate on local content promotion in the oil industry, using the specific case of Sao Tome and Principe as a point of reference.' One country in which the local content debate is currently on the sizzle is Ghana. In 2007, the country, well known for its export of gold and cocoa, discovered oil in commercial quantities. The country's offshore oil reserves discovered so far are estimated at 3 billion barrels, a figure which puts the country in a position to be described as an oil rich country.
This new found source of wealth however poses significant challenges to the West African nation, one of the main challenges being how to ensure that it derives value from its oil and gas production activities for the benefit of the country's estimated current population of 23 million Ghanaians and the local economy.
As part of measures being undertaken to put in place the framework for Ghana's oil and gas production, a Bill entitled the Ghana Petroleum Regulatory Authority (GPRA) Bill was released in October 2008. This Bill when passed into law would serve as the framework for the establishment of the GPRA and its authority for conducting regulatory functions over the industry. Sections 100 to 105 inclusive of the Bill deal with the promotion of local content, specifically, the involvement of the state oil company, provision of goods and services by local entrepreneurs, as well as the employment and training of citizens of Ghana.
It is the writer's hope that this paper would provide a positive contribution to the work of government officials of the relevant Agencies, Members of Parliament and other stakeholders in Ghana, as Parliament considers this Bill.
2. THE LOCAL ECONOMY AND THE HYDROCARBONS INDUSTRY
2.1 CHALLENGES TO THE LOCAL ECONOMY
Various literature provide evidence to the effect that oil wealth or abundance as well as other natural resource wealth produces negative results on a country's economy. Sachs and Warner for instance following an analysis of a number of natural resource economies between 1970 and 1989 found a negative correlation between natural resource abundance and economic growth. Similarly, it has been found that between 1960 and 1990, growth rates in resource rich countries were 2 to 3 times slower than that of non resource rich countries.
It must however be noted that these observations of negativity associated with natural resource wealth though preponderant are far from conclusive. This is because contrary to the above evidence, countries like Norway, Australia, Chile, Botswana and Indonesia which all possess abundant natural resources have performed creditably.
Many of the challenges to economic performance in resource rich countries arise from the nature of the resource industry itself. The industry is characterized by large-scale, capital intensive, high risk investments, requiring high amounts of skill and sophisticated technology. For this reason, many countries at the time of discovery of their natural resources are ill prepared to carry out production on their own. Indeed, the nature of the industry serves as a barrier to local firms especially in developing countries, preventing them from exploiting the resource by themselves and keeping the benefits within the country. It calls for the involvement of IOCs and foreign direct investment (FDI).
As a result of the above involvement of IOCs and FDI, large portions of the income generated from the extractive activity are repatriated to be paid out to shareholders of the IOCs as well as to service foreign debt. In this way, a huge amount of income is lost to the local economy.
There are also limited opportunities in the form of backward and forward linkages for the domestic economy to benefit from the extractive activity. This is due to the capital intensive and highly technical nature of the industry, the export oriented nature of the industry and also the limited absorptive capacity and unpreparedness of domestic firms to benefit from potential spillovers.
Another challenge to the local economy is the volatility of oil revenue. Volatility of oil revenue is due to three factors: the variation over time in rates of extraction, variations in the timing of payments from IOCs to states and fluctuations on the international markets in the value of the oil and gas produced. Revenue volatility has an adverse effect on growth and development of the local economy in the sense that where the economy is highly dependent on oil revenue, it becomes difficult to finance projects started in times of windfall when oil revenue falls, leaving these projects uncompleted. Avoiding the phenomenon known as the 'Dutch Disease' also poses a strong challenge to the local economy upon the discovery of hydrocarbon resources. The Dutch Disease refers to the crowding out of sectors of the economy by one sector, a most obvious example being the crowding out of the manufacturing and agricultural sectors of the economy by the extractive sector. This phenomenon is caused by two factors, the first being an appreciation in real exchange rate caused by a sudden rise in the country's income from natural resource exports. This has the effect of making non natural resource export products uncompetitive on the international market, leading to a collapse of the domestic non natural resource export sector. The second causal factor for the Dutch Disease is the shift of domestic resources in the form of labour and capital away from the non resource export sector to service the booming natural resource sector. This leads to a rise in the cost of these resources to the non resource export sector, causing it to shrink.
2.2 PROMOTING LOCAL CONTENT
The promotion of local content involves the imposition by government of 'conditions on inward direct investments, requiring that a minimum proportion of value-added of the resulting output be derived from host-country goods or services'.
A policy to promote local content may be effected through a framework of legal, regulatory and institutional structures and mechanisms.
The usual conditions or requirements imposed towards the promotion of local content are the use of some fraction of domestically produced goods and services, the participation of a state oil company, the employment and training of local staff and skills and technology transfer to the domestic economy.
3. THE GPRA AND LOCAL CONTENT
3.1 PROVISIONS OF THE BILL
The Bill, entitled the Ghana Petroleum Regulatory Authority Act 2008, seeks 'to establish the GPRA to regulate, oversee and monitor activities in the upstream petroleum industry; provide for licensing in the sector and provide generally for upstream oil and gas in the best interest of the people and future generations of Ghana and for connected purposes'.
Section 100 of the Bill provides for the government's participation in petroleum activity under a licence granted under the GPRA Act. Government participation is to be carried out by the GNPC through a joint venture established by a joint operating agreement in accordance with the licence. The GPRA is given the authority subject to the approval of parliament to specify the participating interest of the NOC in petroleum activities.
Under Section 101, it is provided that the NOC shall under each licence have a carried interest for exploration and development operations and a paying interest for production operations. Additionally, the company has an option to acquire an additional paying interest for development and production operations under each licence.
Section 102 of the Bill deals with the transfer of assets to the NOC. It states that 'A licence shall provide for the transfer to the company of the physical assets purchased, installed, constructed by the contractor for petroleum operations the cost of which has been included in the exploration expenditure, but licencee shall have the use of the assets for the purposes of operations under a petroleum agreement and shall remain liable for maintenance, insurance and any other cost associated with the use.'
The requirement for the provision of goods and services by national entrepreneurs is captured in section 103. Under the section, the licencee is required to 'give priority to a competent entity owned by nationals in the provision of goods and services.' Priority is also to be given 'to the purchase of local products and services from citizens of Ghana where they are competitive in terms of price, quality and timely availability'. In the circumstance that a foreign company is to provide goods and services, the section requires that the company must operate from Ghana and team up with a company owned by a citizen of Ghana.
Section 104 of the Bill is on training and technology transfer. The section requires a 'clearly defined training programme for the local employees of the licencee' together with scholarships and other financial support for education. Where practicable, the licencee is to 'maximize knowledge transfer to citizens of Ghana and to establish in the country any necessary facility for technical work, including the interpretation of data'.
Finally, the requirement for the employment and training of citizens of Ghana is captured by Section 105 of the Bill. Under this Section, a licencee is to submit to the GPRA within twelve months of the grant of its licence, a detailed programme for recruitment and training of citizens of Ghana for approval. The programme is to provide for the training of Ghanaian citizens in all the various stages of petroleum operations. The licencee is also required to publicly advertise for and 'give preference to the employment of citizens of Ghana who have the requisite qualification, competence and experience required to perform the required work.' There is also a requirement under the same section for scholarships to be awarded by the licencee which are not related to the oil industry generally to be submitted to the GPRA for approval.
3.2 LIKELY CHALLENGES TO IMPLEMENTATION
Government's participation anticipated in Section 100 would have its benefits and disadvantages. The benefits include the fact that the state would have greater influence in decisions regarding the commercialization of the natural resource, the NOC would gain knowledge and experience on the running of operations in the oil industry. Also, the NOC would be able to use its influence to get more local companies involved in the oil industry, as well as encourage value added spillovers into the oil and non oil economy. State participation can also serve to satisfy nationalistic sentiments and guarantee the government of a greater share in times of a boom.
The challenges to state participation include the perception that NOCs are commercially inefficient. Indeed, from Nigeria through Indonesia to Azerbaijan, there is evidence to the effect that NOCs are run poorly from an economic and financial view point and have a long way to go in terms of catching up with the efficiency of IOCs. They are characterized by huge losses and political interference.
Again, active participation by the NOC will expose the government to oil industry risks like price fluctuation. This will be so especially when the government exercises its option for a paying interest in production under Section 101 of the Bill. There may also be incidents of conflict of interest arising owing to the dual role of government as the facilitator of regulation over the industry and as a shareholder as well.
PROVISION OF GOODS AND SERVICES BY LOCALS
Achieving this in practice is not as straightforward as it may seem. With the emergence of the new industry, Ghana at present lacks the sophisticated technology, highly-skilled labour force and capacity to provide certain core upstream oil and gas activities like seismic operations, exploration and drilling appraisals, construction of installations for production etc. In the light of this, though there is a requirement for priority to be given to locals in the production of goods and services, this might be difficult to meet in the initial stages with regard to many technical upstream activities.
Another practical situation to watch out for is lack of genuine commitment on the part of IOCs to meeting the conditions for increased local content. In Nigeria for instance, the Petroleum Technology Association found in March 2003 that multinational service providers had resorted to creating bogus companies to fill the local content requirement. The IOCs were also found to be engaging in predatory pricing of upstream contracts to serve as a bar to domestic service providers. Multinationals may also set extremely high standards for quality to the detriment of indigenous companies. This for instance has been the case in Indonesia where the government's requirement for a minimum of 35% local content has been effectively cut down to between 10% and 20% owing to the quality standard set by multinationals.
There would however be numerous opportunities for the domestic economy to benefit in terms of non-core oil activities like hospitality services, office and residential accommodation, insurance, banking, as well as the provision of various services along the supply chain provided they meet the requirements of being 'competitive in terms of price, quality and timely availability.'
TRAINING AND TECHNOLOGY TRANSFER
Technology to be transferred would be both in physical form such as tools, equipment and blueprints and information needed to run the physical equipment effectively.
Since Ghana has little or no previous experience in many of the industry operations, there would be considerable difficulty in practice in absorbing the new technology and processes. Where the technology is complex and recipient firms do not have the capability in the form of skilled staff etc to absorb the technology, the cost of transfer may be very high. The attainment of this objective in the long run will however strengthen local industries and prepare them to gradually take over industry activities initially dominated by multinationals.
EMPLOYMENT AND TRAINING OF LOCAL STAFF
It must be cautioned that the oil industry is a capital intensive and not a labour-intensive one. There are few opportunities for employment in core oil and gas related activities. The Nigeria oil and gas industry for instance began in 1930 and oil was discovered in 1956. Since then, 90% of the country's foreign exchange revenue and 80% of federal revenue has been from the industry. However, over the years, the industry has generated 'few opportunities for employment or income for the majority of Nigerians'. This has resulted in conflict between the indigenous Nigerian community and the oil companies.
Ghana, as it begins its oil and gas production must therefore be wary of expecting too much from the industry in terms of direct employment and income generation.
4.1 LOCAL CONTENT CONSIDERATIONS
In designing a local content policy, the following suggestions may be considered:
Definition of Local Content: There should be a specific and unambiguous metric definition of what constitutes local content. In coming up with this definition, policy makers must be practical enough to realize that there would be areas beyond the technical reach or absorptive capacity of the local economy. In Nigeria, targets of 45% local content by 2006 and 70% by 2010 were set for the country which has been in production for over 50 years. Ghana has a chance to achieve such targets much earlier if the necessary pre-conditions for enhanced local participation in the industry are created in the earliest possible time. Until then, in the writer's opinion a pragmatic starting point for now would be about 30% to be stepped up gradually over the next few years as more Ghanaians are trained and domestic firms prepare to take up more roles in the hydrocarbons sector.
b. Monitoring: There must be the creation of an independent authority responsible for monitoring and ensuring that local content conditions are being met by IOCs. In the U.K this function is performed by the Offshore Supplies Office while in Norway it is the function of the Goods and Services Office (GSO) and in Nigeria the Local Business Development. In Ghana this function may be assigned to the GPRA.
c. Public Outreach: This recommendation is for an office to engage in the registration of competent and qualified local vendors, to inform local vendors of opportunities for joint ventures and other forms of cooperation with multinationals as well as come up with plans to support local capacity building in the form of training, research and development, etc.
4.2 THE ROLE OF GOVERNMENT
Owing to the nature of the petroleum industry as discussed in section two of this paper i.e. the likely barriers to entry by indigenous businesses, the writer is of the opinion that the government of Ghana would have to play a very active role in creating the needed platforms upon which the private sector can spring up to meet the challenging needs of the industry to secure benefits to the domestic economy. The government may play a role in the following ways:
Public Investments: Creating the needed pre-conditions for investment to foster the expected economic boom in the country. This should be through major public investment by government in the form of roads, rehabilitation and expansion of the Takoradi and Tema Ports, facilities for research and development, reliable power generation, education and training and other key infrastructure to serve as a platform for private- investment and long –term growth. The University of Mines in Tarkwa may be expanded to include petroleum activities as well.
b. “Self Discovery”: Government would have to take steps to discover which new profitable activities can be engaged in by the private sector to service the emerging petroleum industry. This is a process referred to by Rodrik and Hausmann as “self-discovery”. A good example of this would be the encouragement of a petrochemical industry, producing products like plastics, rubber, paint, fertilizers, detergents, dyes, textiles and solvents out of oil and natural gas as raw materials. This would contribute to increasing the levels of linkages derived from the petroleum industry.
c. Creation of Incentives: There would be the need for government support to incentivize local firms engaged in activities related to the new industry. Incentives could come in the form of subsidies and tax holidays. Benchmarks may also be set as indicators of success or failure with consequences attached. For instance, subsidies could be withdrawn from firms that fail to do well. This would serve as an incentive for good performance of local firms.
d. Government Participation: As earlier discussed, government can achieve a lot by way of the promotion of local content through the direct participation of GNPC in petroleum activities. The state oil company should not however be used by government as a tool to achieve political ends as has been witnessed with PDVSA in Venezuela and Gazprom in Russia. This is bound to result in inefficiency. The GNPC, if it is to be counted among successful SOCs, like Petrobras of Brazil and Norway's Statoil, should be run with a commercial outlook.
e. Diversification: The above recommended roles of government i.e. making public investments, engaging in “self discovery” and creating incentives are all factors that feed into the creation of a diversified economy. The government must ensure that its move to industrialize is spread across sectors, rather than being confined to the petroleum industry. Opportunities for spillovers from the petroleum industry must be identified and enhanced. Government policies must therefore identify and target links between the oil economy and the non oil economy and areas like agriculture, manufacturing, hospitality services etc.. A diversified economy would provide resistance to oil price volatility and help to avoid the Dutch disease.
The petroleum industry is characterized by certain peculiarities which make it particularly challenging for domestic economies to derive much benefit (both direct and spin-offs) at the initial stages of production. Ghana's attempt to deal with some of these challenges at this early stage through the local content provisions in the GPRA Bill before production begins in 2010 is laudable.
This paper however shows that for Ghana to derive good value in practice from the provisions of Sections 100 to 105 of the Bill, government would have to come up with proactive policies to promote industrialization and diversification to ensure that the local economy can obtain maximum benefit through backward and forward linkages with the new industry. There would also be the need for more detailed and specific regulation by the GPRA to ensure the efficient promotion of local content in Ghana.
Credit: Nana Adjoa Hackman
[The author, a barrister and solicitor, is an LLM Candidate of Petroleum Law & Policy, at the Centre for Energy, Petroleum and Mineral Law and Policy (CEPMLP), University of Dundee, Scotland. [email protected]. The full article will appear in the June edition of the DI Quarterly]