Valuation of 'Start-Up' Oil and Gas and Mining Projects
The Arbitration of the Americas
October 1, 2011
Chris Milburn CMA, CBV
The unprecedented fluctuation in energy and precious and industrial metals prices in the last five years has been a significant catalyst for the flood of resource extraction-related international arbitration cases during that time.
Of particular note are the current international arbitration cases filed involving sovereign governments expropriating declared commercially viable oil and gas and mining concessions from their consortium partners, and disputes between majority and minority shareholders or joint venture partners in the development of such concessions.
Resource development companies are particularly susceptible to expropriation or disputes between development partners in the early stages of production.
In the face of these dramatic price fluctuations, a number of countries with undeveloped oil and gas resources such as Venezuela, Argentina, Equatorial Guinea, Algeria, Angola, Ecuador, Kazakhstan, Russia and others, have sought to adjust the terms of production sharing agreements. This has been accomplished in a number of ways including the imposed ‘additional profits taxes’ or ‘windfall profits taxes’ on profits above a certain level, nationalisation of the sector or type of business by increasing state participation or imposing further limitations or controls on private participation; and modifying the terms and conditions of the granting instruments. A similar trend has occurred in the mining industry where the price of resources had increased substantially, and sovereign governments who had issued mining licences sought to renegotiate, rescind or reassign those licences, or similarly applied some form of a windfall profits tax.
Recent international arbitrations related to the alleged expropriation of resource development investments by sovereigns as well as disputes between joint ventures partners over development of oil and gas and mining concessions have highlighted an intriguing valuation issue: what is the appropriate method to value start-up resource development companies or projects which have very little or no production history?
Resource development companies are particularly susceptible to expropriation or disputes between development partners in the early stages of production. This is because the cost and risks of exploration and development licences for concessions such as oil and gas or mining resources are largely ‘front-end loaded’. Once a project is declared commercially viable and the infrastructure is in place to produce the oil, gas or raw ore and transport it to market, the exploration risk has passed and most of the significant capital development costs have already been incurred, presenting an opportune time for a state government or licence holder to attempt to renegotiate the terms of previous agreements.