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Carole Nakhle, energy economist and research fellow at LCPS

February 2013
Offshore Gas Pre-Qualification Process: So Far so Good

On 15 February 2013, the Lebanese government initiated the country’s first ever offshore licensing round. Companies interested in bidding for oil and gas exploration and production licenses off the Lebanese coast have until the end of March to submit their pre-qualification package. Short-listed companies will be notified by mid-April; bidding will start in May and is expected to continue for six months. Various bid evaluations will take place between November 2013 and January 2014, and the first exploration and production agreement is scheduled to be signed in February 2014.

Lebanon has opted for what amounts to a relatively transparent process for allocating its offshore blocks, in contrast to many developing countries, which often use less transparent methods, such as direct negotiations or awarding contracts on a ‘first-come, first-served’ basis. These latter approaches encourage rent-seeking behaviour and corruption as the criteria for award of contracts are not pre-defined and known to potential investors beforehand. Licenses therefore become vulnerable to favouritism and corruption.

Competitive bidding, if well designed and applied, in principle encourages financially strong and technically competent companies to offer the best terms (highest state take) to the host government to obtain exploration and production rights. In this sense, the approach adopted by the Lebanese authorities can be described as ‘so far, so good’.

Four typical criteria were listed for pre-qualification – specifically legal, financial, technical and environmental. Some countries also add local content. By setting such specific criteria, the Lebanese authorities improve the odds of attracting serious players who are able to carry out capital intensive and risky exploration programmes. Such a strategy is becoming common practice in many developing countries who have in the past suffered from investors acquiring large blocks, sitting on them for a while, with only limited exploration carried out (if any at all), waiting for the right moment to sell for financial gain. 
The application of competitive bidding, the choice of the biddable parameters, and therefore the degree of success of this strategy, nonetheless, vary across countries. Licence allocation by competitive bidding has long been a preferred policy in the United States, where the cash bonus payment – the only biddable item – accounts for nearly 46 percent of the Federal Government’s Outer Continental Shelf revenues. In Norway and the UK, licences are normally awarded on the basis of a proposed work programme. In developing countries, biddable factors can also include state participation, local content, production targets, cost recovery ceiling, and royalty and tax rates. In Lebanon, the biddable items are likely to be the work programme and profit sharing.
Experience shows that there are risks involved in allowing fiscal terms to be biddable. On the one hand, this may create differentiated fiscal structures that apply on different investors, creating an additional administrative burden. On the other hand, some companies offer onerous terms just to win the bid, and then renegotiate the terms if oil and gas prices fall or if subsequent discoveries prove uneconomic.

A combination of factors affects the success of a licensing round, in particular the prospectivity, economic conditions, political risk, legal and regulatory framework, and fiscal terms. This is not an ‘a la carte menu’ from which investors choose. On the contrary, investors weigh various factors together before making a bid. In principle, the size of the bid corresponds to the project’s anticipated profitability and underlying economics, including the impact of the fiscal regime.
It is often argued that competitive bidding tends to be the most successful approach once a proven commercial resource has been established; before such a find the geological uncertainty is likely to discourage large bids. While geological endowment is certainly an important factor, it is not the only determinant of investment decisions. Despite its huge proven oil and gas potential, Algeria's licensing round in 2011 resulted in only two licenses out of ten being awarded - the country’s tough fiscal terms and political risks dampened investors’ enthusiasm.

In Lebanon, more than 40 international oil and gas companies – private and state owned alike – have purchased the seismic data from the Ministry of Energy and Water. This is positive development, creating a competitive framework for the licensing round, adequately reflecting the wide interest. The key point is to realise that interest.

A difference exists between the number of companies that purchase the data, those that pre-qualify, those that actually bid and the number of contracts awarded – the numbers shrink as we move towards the latter category. Iraq best illustrates this case. The country holds more than 127 trillion cubic feet of proven gas reserves, or the equivalent of 1.7% of world total. Its fourth licensing round took place in 2012 and focused mainly on onshore gas exploration. Around 47 companies originally pre-qualified, including oil majors such as BP, Shell and Total. Twelve blocks were offered. When the terms were revealed, only eleven companies actually bid on four blocks. In the event, only three blocks were awarded.

Many eyes are on Lebanon as it tries to navigate a new and long path ahead. So far, the pre-qualification process seems to be in line with international good practice. It looks reasonable and does not create unnecessary constraints that limit potential competition – the latter being an important ingredient for the success of any licensing round. One area of concern is the short time between the announcement of the pre-qualification process and the beginning of the bidding procedure.
A careful design of the bidding process is essential to achieve the country’s desirable objectives. Weak administrative capacity and unfamiliarity with the bidding process among domestic stakeholders need to be addressed. Strong governance, an anti-corruption framework, and non-discriminatory treatment of bidders (especially during the solicitation and evaluation process) are the most important ingredients. In the end, transparency will benefit both the bidders and the country.

This article is published in alakhbar.

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