Local Content: Effective in the Past, Problematic in the Future

National oil companies (NOCs) in developing countries have always had an important role to play in the transfer of technology and skills into the country, and as a vehicle for economic development.  And local content provisions have always had a key role to play in such endeavours.

But recent trends suggest that increasingly restrictive local content requirements will have unintended impacts across a range of issues, including labour costs and the ability of oil companies to deliver projects within challenging time schedules.

Firstly then, what is local content?  Local content is commonly taken to mean the obligation on the investor to use local subcontractors and to purchase a certain amount of supplies and equipment in host country.  Sometimes a target local content is agreed, e.g. 10% of the project, and the host government may impose heavy penalties for failure to comply with the production sharing contract (PSC) or law.  Local content is often the most heavily scrutinised area of investor performance.

Traditionally, the international oil company (IOC) starting position has been that there should be no government interference in prices for equipment and supplies and that market pricing should prevail.  Local content provisions came to be seen by some as another tax which poses irritating logistical challenges such as lack of availability of materials in country and lack of skills in local subcontractors.oil and gas consultants

Despite the higher costs, governments of many oil producing nations have increased local content requirements, which typically enjoys popular public support.  Examples local content provisions are provided below, with the most lenient (from the investor’s perspective) first:

1)  Vietnam:  in the proposed model PSC a Contractor should only be required to give preference to the purchase of Vietnamese goods and services in undertaking operations provided that such goods and services are of internationally comparable quality, available at the required time and quantity, and offered at competitive prices.

2)  Kurdistan:  The contractor shall give preference to personnel from the Kurdistan Region and other parts of Iraq to the extent such personnel have the technical capability, qualifications, competence and experience required to perform the work.

3)  Mexico:  the recent model Integrated Services Contracts require 40% local content (but this could vary in future).

4)  Nigeria:  in 2010 the Oil and Gas Industry Local Content Development Bill was signed into law which stipulated, among other things, a minimum Nigerian content on oil and gas projects of up to 100%, depending on the type of activity.

5)  Brazil:  generally working towards 65%–70% targets for local content, but the average onshore blocks are already over 80% in the 2010 licensing round.

6)  Ghana:  has set a target of at least 90% local content throughout the oil and gas value chain by around 2020.

7)  Gabon:  recently implemented a 90% local content requirement for new contracts.

Of course, in countries where the NOC is dominant, the NOC may set its own targets.  PEMEX has been mandated by the Mexican government to establish a strategy to support national suppliers and contractors as part of an Integral Strategic Business Plan, the purpose of which is to increase local content to a minimum of 25%.

Lagos Oil and Gas Training CourseThe trend seems to be for ever more restrictive local content provisions.  But these do not come without a cost and the implications of high local content can be severe:

1)  Major logistical difficulties for investors in the short and medium term, as local capacity for the delivery of many goods and services may not be readily available.

2)  Reduced growth (or even contraction) of oil and gas production in some countries.

3)  High inflation and other macro-economic impacts as local spending filters through the economy (as an aside, a friend recently spent $20 on a prawn sandwich in Luanda!).

4)  Challenges in the use of some high grade technologies, where the intellectual property rights are normally not transferred by investors to the host countries.

5)  More expensive projects, as local oil services companies generally charge more for equivalent equipment than their international competitors.

6)  Non-compliance and sub-optimal development risks for investors that will be required to be compensated with higher returns.

7)  Administrative burden on investors that are required to account for local content in their projects.

8)  Inconsistency with trade agreements (e.g. NAFTA).

3 Day MBA in Oil and Gas - HoustonSome investors will, of course, seek work arounds to these issues.  For example, in order to meet local content requirements in Brazil, several companies will develop technology centres within the country.

However, the trend is for ever more restrictive local content provisions, and it is clear that unintended consequences could be severe on everyone.

Comments

  1. Hashim Al-Rifaai says:

    I agree with most of what the article had to say. I believe that no one (neither the host nations, nor the contractors/investors) have actually found a way to encourage behaviours that are commercially smart and value adding for both sides which at the same time foster recognition of national potential. Besides “local Content” there have been other instruments used by some nationas, such as “off set programs”. Unfortunately, even that see seen as another form of tax, and contractors try and offloaded as soon as possible, usually in monetary terms; obligating the country to decide how to invest such funds, which defeats the original purpose of co-development to improve national capacity building. forced marriages between national and international enterprises have had similar mixed results. I would like to hear of examples where without any government interference, local content worked exceedingly well voluntarily, and what was the business model.

    • Hashim – thank you for the comment. It will be interesting to see responses to your request for examples. In my own rather narrow experience of training, I see contractors offloading in monetary terms and often the money does not reach its intended target (i.e. the training).

  2. Eniola Somorin says:

    I think a phased approach to implementation of local content initiatives will eventually yield the desired results. In contrast to this an aggressive implementation will change little as indigenous contractors will only serve as proxies for foreign companies resulting in “business as usual” operations without the desired transfer of knowledge, wealth and economic growth.

  3. carlos calad says:

    Although Brazil holds a law that enforces oil companies to comply to up to 75% local content, the market share of local service companies is less than 6%. On the contrary, in Colombia with no specific local content law, local service companies enjoy up to 20% of the market.

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