TRANSACTIONAL: Corporate: International Joint Ventures in the Oil & Gas Sector

by King & Spalding
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[author: Marcus Young]

As growth continues to prove elusive in developed markets, multinational companies in the oil and gas sector are increasingly expanding into emerging markets. This trend has been accelerated by significant new discoveries of reserves, particularly in Africa and places like Mozambique, Tanzania, and Sierra Leone.

Such jurisdictions can be challenging so companies must discover the best model for structuring their investments. International joint ventures (IJVs) between domestic companies and multinationals remain an effective way of accessing such new markets and distribution channels. Indeed, increasingly it is becoming a regulatory pre-requisite to market access for a multinational company to establish an IJV with a local company as a result of efforts by local regulators and national oil companies to ensure the multinationals transfer technology, boost local supplier opportunities, build local skills, and create employment opportunities for nationals.

The popularity of IJVs can mask their complexities. IJVs are hard to negotiate and in practice they can perform unsatisfactorily and often prove unstable.

Given that IJVs are intended to benefit from synergies of co-operation and mutuality, what are the problems that frequently arise when negotiating and operating IJVs in emerging markets?

Agreeing the Deal

Most lawyers will say that the most critical element of getting the deal done is agreeing a joint venture agreement. The agreement is the record documenting the commitment of the partners to making the JV work, so a well-crafted agreement is vital. A joint venture agreement needs to address:

Control

Most multinationals approach IJVs intent on holding and maintaining control through equity ownership. It is not uncommon in emerging markets for local laws to require that the local partner must hold at least 51 percent of the IJV. Even when not legally required, local regulators and stakeholders may still require that a local partner hold a controlling interest as a pre-condition to market access. However, even in circumstances where the parties are free to determine the ownership structure, it is important to note that ‘control’ is not a substitution for effective oversight and governance.

Having 51 percent ownership does not in itself guarantee control. Control is more influenced by governance structure, ownership of key intangibles such as intellectual property and technology, and local and customer knowledge. A key factor in the ‘control’ negotiations is often convincing the local regulator that the management and ownership structure that has been adopted is appropriate to achieve the legislative objectives under national law.

Dispute Resolution

Provisions setting out how to resolve operational disputes between partners are critical, since disputes are almost inevitable in a relationship as complex and dynamic as an IJV.

Dividend policy and other financial matters

Tensions often arise over dividend policy between the local partner and the multinational company, with the multinational often taking a long-term view that emphasises growing market share, long-term value, and supporting key customers in growth markets, whilst the local partner may be more interested in ensuring an immediate and steady stream of dividends for shareholders.

Management responsibility or independence

Studies by McKinsey & Company found that IJVs are more successful if they have strong independent management and mechanisms in place to protect an IJV’s management from excessive parent company interference.

In practice, attempts by the multinational to micromanage an IJV in a distant country are likely to prove difficult. A better strategy may be to set up clear operational parameters and delegate broad powers to IJV management and then let an IJV’s management operate within these pre-agreed boundaries, reserving only certain predetermined matters to the board or shareholders.

Operational Issues

A multinational company often requires an IJV to operate in a complementary manner to its global network, not merely within the local market in which the IJV operates and on which the local partner is focused. Disagreements can arise over the following:

  • Export rights - A multinational often wants to prevent an IJV from exporting products or services into markets which are already served by other manufacturing or service infrastructure in its global network. The local partner, however, often has a different perspective and may expect an IJV to expand into foreign markets including those in which the multinational company already operates.
  • Tax issues - A multinational company may want to utilize transfer pricing techniques - rates or prices that are utilized when selling goods or services between company divisions and departments or parent companies and subsidiaries. Such techniques are intended to ensure the maximum efficacy in a multinational company’s global tax burden, a strategy that is not necessarily consistent with the interests of an IJV.
  • Cultural problems - IJV management is often drawn from different cultures, and misunderstandings can occur. Global enforcement of anti-corruption laws is growing – and many of these prosecutions are connected to IJV transactions. Accordingly, a multinational connected to the US or UK will usually require an IJV to have in place its own compliance policies to ensure the prevention of bribery and/or corruption. Great sensitivity is required, although local partners are becoming increasingly aware of these issues and what multinationals will require in this regard. In addition, local regulators are increasingly keen to demonstrate ‘best practices’ in this area, and accordingly are very supportive of efforts to improve compliance procedures generally.

Conclusions

Although the optimum approach for success will vary depending on transaction- and country-specific factors, there are some key lessons for multinational companys undertaking IJVs in emerging markets:

Identify the right country. Many emerging markets have great potential. However, even very large multinational companys with extensive resources should think strategically about which markets to enter and when. IJVs established without sufficient commitment and focus are not likely to prosper.

Identify the right local partner. Selecting the right partner can often mean the difference between success and failure. A key factor to consider is whether a partner has previous experience working successfully in a similar capacity with another foreign company or investor. It is also important to understand clearly a local partner’s objectives from the outset.

Identify key decision makers and build relationships directly. This factor is critical and especially important when dealing with a national oil company or a local partner in which the state has an interest. An effective strategy is to engage the local regulator early and to share openly localization plans, including those with respect to partner selection and governance of an IJV.

 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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