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Hydrocarbons in Sub-Saharan Africa: Part Two

Hydrocarbon Engineering,

Political risk management strategies

For investors in Sub-Saharan Africa’s hydrocarbons sector, there is rarely such a thing as a ‘good’ or ‘bad’ country. In reality it is more appropriate to think in terms of a good or bad risk. While historically, management of political risk by corporations was considered an oxymoron, today we recognise that companies change and influence the political risk environment they operate within. As such, there are several strategies companies can adopt to manage and mitigate the impact of political risk on their investments.

The first step is to understand that all risk is local and that an integral part of the due diligence process is to review the specific environment in the specific region of the country for their specific project. A review of security on the ground, legacy issues, reputational risk, social impact, environmental impact and relations with the current and potentially future political decision makers in the host country is essential.

The second step to reduce country risk is to identify the range of stakeholders and their respective interests. Stakeholders are not limited to those entities that finance the project and include the host government, local government, community groups or tribes, project sponsors, lenders, offtakers and NGOs.

The third step is to ensure equitable reward sharing between project sponsors, the host government and other participants. A major driver for resource nationalism has been perceived inequality in returns when commodity prices rise. One way to address this is to link government royalties to profitability and commodity prices. Direct government equity participation in projects can also be a risk management tool and may be an alternative to the royalty structure.

The fourth step is to engage with non-governmental stakeholders. Many operational NGOs are more appreciative of the developmental benefits of investing in the resources sector and are willing to work with foreign investors. Their local expertise may prevent the project company from inadvertently creating new risks and, for example, in developing local infrastructure can advise on balancing the interests of competing tribes, employing from across ethnic groups and sensitivities to such things as religious and historical sites.

The fifth step is to consider the benefits engagement with multinationals may bring. As a preferred sovereign creditor, the World Bank wields considerable influence in the event of contractual disputes and defaults with emerging governments. This influence is reinforced by the World Banks’s role as a key source of liquidity when a country is in turmoil.

The sixth step is to consider recourse under bilateral investment treaties (BITs) which have long provided a valuable source of risk mitigation and valuable safety net to counter the worst excesses of government behaviour.

The seventh step is to provide adequate protection for personnel. In conjunction with ensuring operational continuity, companies owe a basic duty of care to their employees and must ensure that suitable security plans are implemented and regularly reviewed to minimise the risks of an incident occurring. Risk cannot be completely removed from a project and should an event happen the company needs to have an effective crisis plan in place, which will include access to specialist third party service providers for medical or political evacuation or kidnap response.

The eighth step in the risk management process is to insure these risks. Political risk insurance (PRI) can insure against loss to foreign lenders, investors, suppliers and traders with mining companies. There are a range of perils that these risk participants may be exposed to depending on the specific project, the basis on which it trades, the location and associated contractual agreements.

A key issue that is often misunderstood when looking at political risk in the hydrocarbons sector is the idea that the key asset to be insured is the mineral reserves. In the private sector the asset is in fact the right to explore for and receive a share of the revenue derived from natural resources, not an ownership right over those resources. This means that the fundamental peril for investors in and lenders to resources projects is often the repudiation of the operating agreement by the host government and not the confiscation of the mineral assets. This is crucial in an era where government action may take different forms that are not of the character of expropriation as has been traditionally understood but do constitute a repudiation of existing operating agreements, often through a process of ‘creeping expropriation’.

The private PRI market, comprising of nearly 50 syndicates and companies, has theoretical capacity for a single project in excess of US$ 1 billion. Securing this capacity and agreeing conditions and a competitive price is most successfully achieved by demonstrating clear identification of the underlying perils and appropriate risk management. Political risk underwriters of resource projects pay careful attention to due diligence and do distinguish between the qualities of similar projects in the same territories.

PRI will not fix a bad deal or contract but when a project is well structured and the correct PRI coverage purchased, it effectively neutralises country risk and provides an effective safety net for Sub-Saharan Africa hydrocarbon investments.

Written by Elizabeth Stephens, Jardine Lloyd Thompson, UK and edited by Emma McAleavey.

To read the full version please download a copy of the May issue of Hydrocarbon Engineering.

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