How to Select Buyers of Oil, Gas and Minerals

2. Designing the buyer selection process

2.1. Reducing discretion in the buyer selection process

Box 2.1. What SOEs can do to reduce discretion in the buyer selection process

• Set pre-determined and objective buyer selection criteria to be explicitly and transparently considered in the buyer selection processes;

• Limit political interference in SOEs’ technical decisions by making merit-based appointments. Invest in staff integrity and capacity and adopt strong employee accountability provisions;

• Introduce standardised and automatic procedures (e.g. bid submission, revenue collection etc.) / develop standardised models or guidelines (e.g. contract terms); and

• Set clear ethical standards and codes of conduct and provide certification and regular training for SOE employees in compliance-sensitive positions.

Source: Adapted from (OECD, 2016[5]).

Discretionary power and a high politicisation of decision-making in the buyer selection process can result in significant public rent diversion. The discretionary power over decision-making held by both high and lower-ranking public officials is a major risk factor and undermines the effective prevention of corruption in the buyer selection process.

Discretionary decision making can result in the selection of buyer who may purchase the commodities for less than their market value, or who may not have the requisite financial and technical capacity to meet their obligations under a commodity sales contract. In practice, these ‘unqualified’ buyers are often intermediaries, who purport to act as the buyer in the transaction purchasing the commodity at a low price before quickly off-selling the commodity at a market price on the international market, without providing any logistical or other reasonable service. The buying company thus acts as a mere intermediary between the public entity or its marketing agent and a second-tier purchaser (OECD, 2016[5]).

2.2. Determining the type of contractual arrangement

SOEs will need to decide which type of contractual arrangement is most appropriate in their given context. The types of arrangements that are used to sell commodities need to be carefully considered due to the large amounts of financial flows involved and the corresponding potential high risk of corruption and public rent diversion.

There are several different methods that a SOE may use to select buyers of its oil, gas or mineral resources which can depend on strategic as well as economic factors. These arrangements may include: spot sales, term arrangements (short, medium and long-term) and government-to-government (G2G) transactions. Other factors that can influence the buyer selection process include: financing (resource-backed finance agreements); the procurement of products for the domestic market (commodity-for-product swap agreements); or the desire for a long-term relationship with an end user.

SOEs are not limited to the use of one type of contractual arrangement. For example, in Chile, Codelco uses both term sale agreements (80%) and spot sales (20%), whilst 5% of Codelco’s sales are made using resource-backed finance agreements. In Ghana, GNPC uses both spot sales and term agreements for the sale of its crude. GNPC has two long-term agreements with Unipec Asia (15.5 years) and Litasco (5 years) to lift crude oil from GNPC’s share of the Jubilee and TEN oil fields at a rate of approximately 5-8 lifting per year. If there is excess crude oil available after the liftings, GNPC will use the spot sales method to sell that additional crude oil (GHEITI, 2018[12]).

2.2.1. Spot sales

Spot sales are used by both NOCs and NMCs to select buyers for their oil, gas and minerals but are more common in sales of crude oil. Around a third of all sales of crude oil are made using this arrangement (Van Schaik, 2012[13]). Spot markets operate in real-time and can offer SOEs an instant sale and disposal of their commodities. Spot markets operate wherever the necessary infrastructure exists to conduct the transactions, and by using this method, SOEs will usually receive payment immediately or within a short time window.

Among the SOEs surveyed by the OECD Development Centre in 2018, several reported the use of spot sale arrangements. In Mexico, PMI reported that during the period 2015-17, 27% of the value of total export sales were made by spot sale method. Staatsolie reported 48% sales were made via this method and Ecopetrol reported that 58% of sales were sold via spot sales (OECD Development Centre, 2018[9]).

In order for SOEs to take advantage of the spot sale method, the necessary infrastructure should be in place to allow these sales. Furthermore the SOE will need a sophisticated trading desk to regularly monitor the market and position itself to be able to exploit the slightest supply disruption whilst avoiding demand weakness (Van Schaik, 2012[13]).

2.2.2. Term sale arrangements

Term sales refer to an arrangement where the SOE negotiates a contract with a buyer to supply a commodity over a longer time period, usually with a minimum of one year. The term arrangement will specify how the price will be determined, the total units of the commodity that will be sold, the point of delivery, and other contractual factors.

Term sale arrangements are used by SOEs to sell oil, gas and minerals, with around a two thirds of all crude oil sales sold via this method (Van Schaik, 2012[13]). In Mozambique, ENH sells the government’s share of natural gas exclusively through term sale arrangements, usually for periods longer than ten years. In Colombia, in 2017, Ecopetrol sold 42% of the total value of its oil sales through term arrangements usually for a period of two years.

Term sale arrangements can provide SOEs with increased certainty and stability in regard to future revenue flows. SOEs should ensure that they are in a position to deliver on their supply obligations under a term sale arrangement, and have contingency plans in place to counter any disruption to supply.

2.2.3. Commodity-for-product swap agreements

Commodity-for-product swap agreements refer to an arrangement where an SOE ‘swaps’ commodities – usually crude oil, for other commodities – usually refined petroleum products. The past or current use of these swap agreements has been documented in Angola, China, Indonesia, Kuwait, Malaysia, Nigeria, Saudi Arabia and Venezuela.

These arrangements may be negotiated when the government is at a weak bargaining position, for example, when demand for their commodity is low or when they cannot pay cash for the refined products they require. Furthermore, since commodity-for-product swap agreements are highly context-specific, there are few industry standard terms or “best practices” against which to measure them – which makes undervaluation and mispricing difficult to identify.

Commodity-for-product swap agreements may offer opportunities for corruption and misappropriation of oil rents as suggested by large discrepancies observed between benchmark estimates and actual figures for government revenues in certain oil producing countries. The absence of money transfer and the secrecy surrounding contractual clauses make corrupt behaviours difficult to detect (OECD, 2016[5]).

The scale of commodities sold through commodity-for-product swap agreements can be quite significant. In Nigeria, between 2010 and 2014, NNPC sold oil worth USD 35 billion through one of these arrangements. In 2015, NNPC sold 210 000 barrels per day (which was one-tenth of Nigeria’s entire production) through swap agreements. NRGI estimated a loss of USD 16 per barrel in public revenues due to unbalanced contract terms (Sayne, Gillies and Katsouris, 2015[14]).

Given the opacity of these arrangements and the opportunities for corruption and misappropriation, the use of commodity-for-product swap agreements should be carefully considered, to avoid the risk of underselling the resources.

2.2.4. Resource-backed finance agreements

Resource-backed finance agreements have become common over the last few decades, in particular for countries with limited access to capital and credit that use their resource wealth to secure financing. These can take the form of pre-payment or advance payment deals, where a government or SOE receives funds up-front in exchange for future resource production. Commodities can also be used to repay public sector debt, or used as collateral. The political pressure faced in some countries to spend commodity revenues quickly may lead to the negotiation of pre-payment arrangements granting favourable conditions to the buyer at the expense of the seller (e.g. discounted prices).

The disclosure of select information in respect of resource-backed finance agreements is required under the 2019 EITI Standard. Requirements 4.2.a and 4.3 require, at a minimum, disclosures on the terms of relevant agreements, parties involved, resources pledged, the value of the loan, and the volume and value of commodities exchanged (EITI, 2019[3]).

Whereas resource-backed finance agreements offer countries opportunities for access to finance, these loans also come with considerable risks, sometimes very onerous terms, and are not contracted on a competitive basis. Recent research by Public Eye illustrates how the use of resource-backed finance agreements can lead to significant public rent diversion (Public Eye, 2017[15]).

Governments may also under-value the country’s future oil revenues in order to receive short-term injections of cash, often for political reasons. Furthermore, these agreements are frequently non-transparent to citizens, and off the government budget. Sometimes these loans are non-transparent even to the government of the borrowing country, if contracted by a SOE unbeknownst to the government.

Lack of public oversight of resource-backed finance agreements can push governments into debt distress, put sovereignty over public assets at risk, interrupt access to assistance from international financial institutions, and stifle the long-term development of borrowing countries.

2.2.5. Government-to-government sales

Governments may direct an SOE to sell commodities to another government for commercial or political reasons. The direct offer of commodities to other governments could be a method to secure long-term buyers for those commodities or may be in pursuit of unrelated foreign policy objectives. The use of this method has been documented in sales of commodities from Colombia, Nigeria, the Russian Federation and Venezuela.

In Colombia, in 2017, Ecopetrol sold 24.5% of the total value of its commodity sales via SOE to SOE arrangements. The 2018 Invitation to Tender for the Sale and Purchase of Nigerian Crude Oil Grades sets out a list of the types of buyers who may apply and includes “Government to Government arrangement (Bilateral relationships) with high energy consuming countries” (NNPC, 2018[16]).

Since the 1970s, NNPC has regularly sold crude oil to other countries, including BRICs, a few state-owned West African refiners, and other smaller African countries who do not always have refineries. These government-to-government sales are estimated to range from 8% to 24% of NNPC’s total oil sales (Sayne, Gillies and Katsouris, 2015[14]).

2.3. Determining the allocation method for buyer selection

Box 2.2. What SOEs and governments can do to reduce opacity in the bidding process

• Make information related to all stages of bidding processes publicly available to all stakeholders. Such information may include timelines for submitting bids, selection and evaluation criteria, contract award decisions as well as other critical information, such as the list of applicants (OECD, 2014a);

• Disclose any material deviations from the applicable legal and regulatory framework governing the selection of buying companies (Requirement 4.2(b), 2019 EITI Standard);

• Appoint independent bodies responsible for the technical design of the bid and the oversight of the bidding process (ICAC, 2013);

• Ensure effective management of possible conflicts of interest and clear segregation of roles (design, evaluation and selection of the bid);

• Where possible, put in place an online submission process to increase transparency and limit interaction between SOE employees in charge of the bidding process and bidders;

• Debrief bidders on how the award decision was made;

• Establish dispute mechanisms to enable losing bidders to challenge the results in case of discontent; and

• Mandate that awarded commodity sale agreements are fully disclosed in publicly available registries and open to scrutiny.

Source: Adapted from (OECD, 2016[5]).

SOEs will need to decide which buyer selection method is most appropriate in each given context, and should develop a robust framework that sets out how this decision is made. SOEs may use a competitive bidding process, a direct negotiation with the buyer or a mix of both of these methods. Often the choice of the buyer selection method depends on the market for the particular commodity or other factors, such as when commodities are sold under resource-backed finance agreements.

For example, in Colombia, the particular buyer selection method is defined by the availability of crude oil at a given point in time and refined products as well as Ecopetrol’s commercial strategy. Consequently, Ecopetrol sells approximately 85% of crude oil through a direct negotiation method and sells approximately 90% of refined products through a competitive bidding process (OECD Development Centre, 2018[9]).

SOEs should use a competitive bidding process, unless there are specific reasons for using a different method. In some situations, a competitive bidding process to select buyers may not be appropriate. These include instances where governments and/or SOEs are seeking loans from a buyer where repayment is made directly by the future production of natural resources (resource-backed financing agreement), or where SOEs wish to establish a long-term commercial relationship with an end user for commercial or strategic reasons (OECD Development Centre, 2018[17]). Prior to each buyer selection process, SOEs should disclose the buyer selection method that will be used and an explanation on why that particular procedure was selected.

2.3.1. Direct negotiation with buyer

This method involves the direct negotiation of a commodity sale agreement between the SOE and a buyer in a non-competitive context.

Factors that may lead to the decision to sell commodities by this method may include the desire for a long-term commercial relationship with an end user (e.g. refinery) or the perceived lack of interest by buyers which would not justify the cost and resourcing of a competitive bidding process.

SOEs that choose to sell commodities by directly negotiating with a buyer should ensure that the buyer can satisfy the minimum selection criteria and has the capability to give effect to its obligations under the commodity sale contract (see Section 2.4 below).

Box 2.3. What SOEs can do to reduce corruption risk in direct negotiations

• Disclose the reason(s) for why a direct negotiation was chosen over a competitive bidding process. This method of buyer selection does not necessarily justify less transparency. On the contrary, it may require even more transparency to mitigate risks of corruption;

• Develop standardised models or guidelines for contractual terms in order to minimise discretion in direct negotiations;

• Appoint an independent probity advisor (ideally from outside the SOE) who should be present at key points of the decision-making process and who should observe the negotiations with the buyer;

• Conduct an independent review or audit following each use of the direct negotiation method; and

• Require parliamentary approval for entering into significant long-term commodity sales agreements through direct negotiations.

Source: Adapted from (OECD, 2009[18]).

2.3.2. Competitive selection

Box 2.4. What SOEs can do to reduce risks of bid rigging in a competitive selection process

Be informed before designing the competitive selection process

• Be aware of the characteristics of the specific commodity market and trends that may affect competition for a competitive selection process;

• Determine whether the specific commodity market has characteristics that make collusion more likely;

• Be informed about pricing in neighbouring geographic areas for similar commodities, and collect information about past competitive selection processes for the same or similar commodities;

• Ensure that if external consultants are used to help with estimate pricing that they have signed confidentiality agreements.

Design the competitive selection process to maximise the potential participation of genuinely competing bidders

• Consider reducing any constraints on the participation of foreign bidders in the competitive selection process;

• Reduce the preparation costs – i.e. by using an electronic bidding system;

• Do not unnecessarily limit the number of bidders in the bidding process.

Design the competitive selection process to effectively reduce communication among bidders

• Limit as much as possible communications between bidders during the competitive selection process. A requirement that bids must be submitted in person provides an opportunity for last minute communication between rival buyers. This could be prevented, for example, by using electronic bidding;

• When disclosing information about a completed competitive selection process, avoid disclosing competitively sensitive information as this can facilitate the formation of bid-rigging schemes, going forward;

• Include in the tender/auction offer a warning regarding the sanctions for bid rigging, e.g. suspension from participating in tenders/auctions for a certain period, the possibility for the SOE to seek damages, and any sanctions under the competition law.

Carefully determine the selection criteria

• When designing the selection process, think of the impact that the choice of criteria will have on future competition;

• Whenever evaluating bidders on criteria other than price (e.g. technical aspects, local content requirements, etc.) such criteria need to be described and weighted adequately in advance in order to avoid post-award challenges;

• Reserve the right not to award the contract if it is suspected that the bidding outcome is not competitive.

Source: Adapted from (OECD, 2009[19]).

A competitive selection refers to the process where two or more potential buyers submit competitive bids that are assessed against set criteria, and where a commodity sale contract is awarded to the winning bidder. A competitive selection may be referred to as a tender, an auction, a bidding process/bidding round or other similar terms.

The majority of the SOEs surveyed by the OECD Development Centre in 2018 reported that a competitive bidding process was their preferred method of buyer selection. This applied equally across national oil companies and national mining companies.

A competitive selection process can be used to encourage the submission of several quality bids from established and legitimate buyers. However, SOEs should ensure that the competitive selection process is designed to promote competition and to reduce the risk of corruption or the manipulation of the process.

SOEs should be aware of the potential for bid rigging, i.e. agreements between bidders to eliminate competition in the selection process, which is a major risk to the effectiveness and integrity of the sale process and can deprive the SOE, and ultimately the state, of the genuine proceeds from the sales of its natural resources.

Bid rigging happens when potential buyers interfere with the standard operation of a competitive tender, for example, by conspiring to lower the price offered for the purchase of publicly owned commodities. Efficient and competitive selection processes are thus key to preventing this practice. Bid rigging is more likely to occur when a small number of companies participate in a competitive selection process. The fewer the number of buyers, the easier it is for them to reach an agreement on how to rig bids.

Prior to holding a competitive selection process, SOEs should determine an internal threshold of a minimum number of bidders where collusion or bid rigging would be highly unlikely. Subsequently, if a competitive selection process is held where the number of bidders falls below that threshold, this will signal that further scrutiny is required.

In addition, each competitive selection process should be audited and the audit should, among other things, seek to identify any instances where bid rigging/collusion may have occurred.

SOEs may choose to set a price threshold for a competitive selection process to protect the SOE from a situation where the highest bid is significantly below market value. For example, in Botswana, Okavango Diamond Company (ODC) may at any time before the commencement of an auction set a reserve price at which it is willing to sell each lot of diamonds. In this situation, ODC is not obliged to disclose this reserve price to any bidder (Okavango Diamond Company, 2019[20]).

Box 2.5. What SOEs can do to detect bid rigging in a competitive selection process

Red flags when buyers are submitting bids

• Certain companies always submit bids but never win;

• Each company seems to take a turn being the winning bidder;

• Some companies unexpectedly withdraw from bidding;

• There are an unusually low number of bids.

Red flags in the documents submitted with the bid

• Identical mistakes in the bid documents submitted by different companies, such as spelling errors;

• Bids from different companies contain similar handwriting or typeface or use identical forms or stationery;

• Bid documents from different companies indicate numerous last minute adjustments, such as the use of erasures or other physical alterations.

Red flags in the behaviour of the bidders

• A company submits both its own and a competitors bid;

• A bid is submitted by a company that is incapable of successfully completing the contract;

• Several bidders make similar enquiries to the SOE or submit similar requests or materials.

Source: Adapted from (OECD, 2009[19]).

SOEs can make use of technology to design and carryout robust competitive selection processes. For example, in Botswana, ODC uses a transparent online platform to enable the sale of diamonds by auction.

ODC requires buyers to register in order to be qualified to participate in diamond auctions. The registration process is conducted entirely online, which improves efficiency but also limits the amount of human interface between the SOE and potential buyers prior to the actual buyer selection.

Once registered, potential buyers are able to participate in ODC’s diamond auctions. These auctions take place online using a secure and fully auditable online auction system that was developed by a leading online auction provider. During the course of the auction, bidders are provided with real time auction feedback allowing them to make informed bidding decisions. The auction process cannot be manipulated by the company and the results are based on purely commercial considerations (highest bidder wins).

Within 24 hours of an auction taking place, the sales results and the prices paid are publicly available on the ODC website. The winning bid is disclosed and invoices are sent out within a 12 hour period. The use of a fully online auction platform can assist transparency and accountability. The ODC auction process is fully auditable as each click of the mouse by bidders (successful and unsuccessful) can be tracked and audited (OECD Development Centre, 2019[21]).

2.4. Setting out the terms of the buyer selection process

2.4.1. Pre-qualification process

The pre-qualification of potential buyers can provide a set of reliable buyers with an adequate standard of financial and technical capability, and can provide SOEs with more time to focus on the second part of the bid process, including the pricing/valuation of the commodity. In terms of the criteria used to select buyers, two main components are ordinarily set out:

• technical capability – the ability of the prospective buyers’ to lift the commodity and their commercial experience with markets; and

• financial capability – the potential buyers’ credit rating, bank credit line, etc.

In some jurisdictions, local participation may be an additional component if the state seeks to develop the local capacity for trading. For example, both GNPC (Ghana) and NNPC (Nigeria) have set out criteria for local content requirements.

The pre-qualification process can act a ‘first check’ of a company’s credibility before a more thorough assessment is undertaken later, or can act as a screening process to ensure that only companies that fit a certain profile can move forward to the next stage.

SOEs should prevent the manipulation or abuse of the pre-qualification process, in particular by politically connected briefcase companies. Section 3.2 provides additional guidance on how SOEs can undertake due diligence on potential buyers.

SOEs should ensure that potential buyers are required to submit sufficient and detailed documentation to enable a robust assessment of their value proposition. For example, in Botswana, ODC undertakes a two-stage process to pre-qualify potential buyers.

Firstly, an internal audit is undertaken to assess whether there are any issues with the potential buyer that could bring ODC or Botswana into disrepute. This includes a background check on both the parent and subsidiaries of the potential buyer. If the potential buyer passes the first stage, an independent verification check is then undertaken. ODC will send the pre-qualification application to a third party agency that has access to relevant global databases to undertake a second check, which includes compliance with anti-money laundering (AML) requirements and international sanctions. ODC allows intermediaries to participate in the sales process but must go through the same two-stage screening process and satisfy the same requirements.

Once an SOE has screened a prospective buyer who satisfied the requirements, they are placed on a list of companies who may participate in future competitive bidding processes. SOEs should revisit this list of pre-qualified prospective buyers regularly to ensure that those companies continue to meet the criteria. For example, GNPC and Staatsolie perform this check before each tender/sale, Ecopetrol and Petrotrin perform this check annually (OECD Development Centre, 2018[9]). In Botswana, ODC reviews its pre-qualified buyers every three years to ensure ongoing compliance with globally accepted ethical trading. SOEs should consider disclosing the list of pre-qualified prospective buyers (see Box 3.1).

2.4.2. Pre-defined criteria to select buyers

Pre-defined criteria can be applied at different stages during the selection process. The assessment of a buyer against pre-defined criteria may occur at a pre-qualification stage, at a subsequent assessment stage (i.e. during a tender), or, as is often the case, during both stages.

An SOE will likely tailor its pre-defined criteria to the nature of the commodity being sold and other commercial and strategic factors but may also take into account domestic (political, economic and social) concerns. For example, in Mozambique, when selecting buyers of tranches of natural gas, ENH takes into account the quantity of the gas required and the price proposal but will also consider: employment, development of social infrastructure, local content and the involvement of public and private partnerships. In Mexico, PMI executes its oil marketing strategy by selecting buyers in the international market according to several factors, including: the type of crude oil, volume and term of availability, international market conditions (global and regional supply/demand, price, plant capacity, operation rates, outages) and quality, alongside the prospective buyer’s financial and technical capabilities. As with NNPC in Nigeria, PMI also requires its buyers to fit a certain business model – they must be end users (i.e. refineries).

SOEs should ensure that their pre-defined criteria includes a requirement for the buyer to provide sufficient information to enable verification of the buyer and its beneficial owners.

Technical capability

SOEs should set out technical criteria that a prospective buyers must meet in order to ensure that the buyer is able to lift, process, refine, and/or use the commodity in question. For example, in Mexico, PMI assesses the type of crude oil, volume and term of availability, international market conditions and quality, alongside the prospective buyer’s technical capabilities.

In Ghana, GNPC will send a request for proposal (RFP) to selected companies on GNPC’s list of pre-qualified buyers based on the grade of the particular crude oil and the experience of the pre-qualified buyers. GNPC focuses on the prospective buyer’s ability to lift a cargo of crude oil, as well as their commercial strategy. When selecting a marketer, GNPC will take into account the companies experience and flexibility in marketing crude oil, as well as health, safety and environment (HSE) capacity building factors.

SOEs can seek to optimise the value of their commodities by identifying the market where that commodity will yield the best value, and including this factor in their selection criteria. For example, it has been noted that for many NOCs, Asia has been the highest value market for crude oil in recent years (Van Schaik, 2012[13]).

In Iraq, SOMO takes into account the location of the prospective buyer by giving priority to the Asian market, while also considering giving priority to companies that hold large refining capacities, and promoting the expansion of Iraqi crude oil in key global markets. To this end, SOMO classify prospective buyers into three categories:

• Reputed International Oil Companies: well-known international oil companies (big and medium size), independent, governmental, well-structured companies that have refining capabilities and distribution network in many countries.

• Refining Companies: companies majoring in the refining industry and distribution of oil products.

• Authorised Companies: companies classified as main providers to refining companies in their country (IEITI, 2016[22]).

Financial capability

SOEs should set out financial criteria in order to gain an understanding of the prospective buyer’s ability to make payment to the SOE for the commodities concerned. This may require prospective buyers to provide evidence of a line or credit from a reputable financial institution or to demonstrate their ability to directly pay for commodities they wish to purchase. SOEs should ensure that they have sufficient expertise and resources to conduct a thorough assessment of the financial information provided.

For example, in Colombia, Ecopetrol requires evidence of the buyer’s financial capability and also carries out their own analysis of the buyer’s liquidity, solvency, and profitability ratios and third-party rating reports. In Suriname, Staatsolie require prospective buyers to provide information on its company details, banking details and annual reports.

Box 2.6. Financial information required by NNPC at the pre-qualification stage

• Audited accounts for the past three years which must bear the stamp of the audit firm;

• A demonstration of minimum annual turnover of USD 500 million (or the Naira equivalent) and net worth of not less than USD 250 million (or the Naira equivalent) for the financial year ending of 2016; and

• The ability to establish an irrevocable letter of credit for the payment of any allocated crude oil subject to the contract terms – to ensure that the prospective buyer is able to pay for the shipment of crude oil is wishes to purchase.

Source: (NNPC, 2018[16]).

Local participation

SOEs may include local content requirements in their selection criteria in order to boost the participation of local entities in the commodities value chain. This requirement may be a specific policy set by the SOE or may be in accordance with a broader legislative requirements.

When SOEs set stringent criteria for the selection of buyers, this can result in local companies being outbid by large international buyers that are more able to meet these stringent criteria. Consequently, the inclusion of local content requirements in the buyer selection process can assist a country in developing its local trading capacity (OECD Development Centre, 2018[17]).

Local content requirements are ordinarily intended to encourage the participation of local entities as joint venture partners, rather than as the sole buyer in the transaction. SOEs should be aware that the requirement to involve a local joint venture partner in a sales transaction carries increased corruption risk, especially in cases where there is an absence of clear rules for the identification of the local company or where discretion is left to the government to identify such local partners (OECD, 2016[5]).

In order to reduce corruption risks associated with local participation, SOEs should set out clear, specific, objective criteria for the selection of a local partner in order to reduce discretion being applied on a case-by-case basis, and should ensure that all information related to existing local content requirements and pre-qualification criteria publicly available and easily accessible.

Where local content targets are in place, SOEs should also assess whether they reflect the sector’s needs and available local capabilities. In terms of potential local partners, SOEs should establish a register based on certification schemes or objective and publicly available evaluation criteria, and ensure mechanisms for banning local enterprises from the register for a defined period of time in cases of non-compliance with anti-corruption laws and policies, and depending on the seriousness of the violation concerned (OECD, 2016[5]).

Box 2.7. What SOEs can do to reduce corruption risks associated with local participation

Identification of red flags:

• The local company and/or its principals have no prior relevant operational experience;

• The local company and/or its principals have little or no industry reputation or name recognition;

• The local company was incorporated or otherwise legally registered only shortly before, or even after, the commodity sale. It may appear that the local company was set up specifically for this particular commodity sales transaction.

Source: Adapted from (Sayne, Gillies and Watkins, 2017[23]).

Local content requirements are more prevalent in oil and gas sales than mineral sales. For example, in Nigeria, NNPC’s Invitation to Tender for the Sale and Purchase of Nigerian Crude Oil Grades states that “compliance with Nigerian Content Act shall be a major consideration in the selection of applicants to lift Nigerian crude oil. It should be noted that evidence of Nigerian equity in the entity seeking consideration shall give competitive advantage” (NNPC, 2018[16]).

In Ghana, GNPC requires each buyer of its crude oil cargoes to have a “local partner”, whist in Mozambique, ENH when selecting buyers of tranches of natural gas, takes into account local content, employment, and development of social infrastructure (OECD Development Centre, 2018[9]).

Additional criteria

In addition to the financial, technical and local content criteria set out above, SOEs may wish to include criteria to screen potential buyers’ on their integrity. For example, this may include criteria in respect of: anti-corruption, ethics, as well as corporate social responsibility (CSR), including environmental, social, and labour standards.

SOEs may consider the inclusion of additional criteria in response to the many corruption challenges that can arise in commodity trading transactions.

SOEs will need to decide which specific criteria to include (anti-corruption, environmental etc.), and then potential buyers should be required to provide sufficient information on these aspects, including their corporate policies, to enable verification and assessment by the SOE.

Weighting of marks

In order to reduce the exercise of discretion in the buyer selection process, SOEs should use a weighting system to assess a prospective buyer against the pre-defined criteria.

A weighting system can assist in situations where a prospective buyer may be able to demonstrate its ability to meet some of the criteria but may have difficulty in meeting other criteria. A weighting system can also assist SOEs in determining the extent that non-financial and technical criteria, for example, local content requirements, should be taken into account.

SOEs that use a weighting system should clearly set out the parameters of this system in advance. For example, in Mozambique, ENH sets out its weighting system in the terms of reference for its natural gas tenders. ENH’s weighting system takes into account five key factors when assessing a buyer against its buyer selection criteria (Mozambique Ministry of Energy and Mineral Resources, 2016[24]):

• Documents are in compliance with the law (20%)

• Social impact of the project (10%)

• Economic impact of the project (20%)

• Quantity of gas required (10%)

• Price proposal (30%).

Table 2.1. Weighting criteria used in the buyer selection process by GNPC

Technical terms (75%)	Ability to lift and strategy (15%)	Shipping	3%
		Experience in trading crudes	4%
		Refineries/options	3%
		Sales/marketing strategy	5%
	Flexibility of marketing (10%)	Ownership/access to dedicated vessels	2%
		Access to wider market	5%
		Access/partnership with refineries	3%
	Experience in marketing new crude oil (10%)	Number of crudes marketed	6%
		Marketing West African crudes	4%
	HSE (5%)	Proof of good safety record	5%
	Capacity building (5%)	Provision of training for GNPC staff	5%
	Local content (30%)	Evidence and terms of partnership	5%
		Strength of local partner	10%
		In-country presence & investment	15%
Commercial terms (25%)	Strategy to achieve the best price (differential) proposed		10%
	Marketing fee		5%
	Pricing option		5%

Note: This criteria may be tweaked by GNPC to suit particular situations – for example, the Technical criteria – Experience in marketing new crude oil – will be included for a tender of a new crude but not for an established crude.

Source: Adapted from the presentation by GNPC to the Tenth Plenary Meeting of the Policy Dialogue on Natural Resource-based Development on 26 June 2018.

2.5. Establishing a pricing policy

Box 2.8. What SOEs can do to prevent losses associated with commodity mispricing

• Set a clear pricing formula derived from publicly quoted prices prior to entering into negotiations with a buyer or holding a competitive selection process;

• Utilise commodity benchmarks (with a premium or a discount adjustment to suit the specific commodity/circumstances) where applicable;

• Consider disclosing pricing formula to market participants; and

• Include a pricing adjustment mechanism in long-term sales agreements to ensure that prices are reviewed in order to reflect market value across the life of the contract.

2.5.1. Overview

Undervaluation and mispricing can result in significant revenue losses for an SOE. Mispricing in commodity trading usually consists of under-reporting volumes or under-invoicing the value of the resource sold, allowing its purchaser to resell it at an inflated margin.

Pricing may be affected by the choice of contract (spot sales, term arrangement) that underlies the commodity sale transaction. For example, a buyer entering into a commercial relationship with the seller to purchase a commodity over a long time horizon, and therefore providing a reasonable certainty of future revenue for the SOE, may have this factor reflected in the sale price.

Consequently, SOEs should ensure that a robust pricing policy/formula derived from publicly quoted prices that reflect market value is developed prior to entering into negotiations with a buyer or holding a competitive bidding process.

For example, in Ghana, GNPC uses the following pricing formula when selecting buyers for crude oil cargoes: Unit price (USD/Bbl.) = Dated Brent Price + Differential + Pricing Option Fee minus Marketing Fees (if Applicable). For example, in GNPCs offtake agreements, the buyer has a choice of four different pricing options. Any option exercised by the buyer attracts a margin. The options are:

• The average of five consecutive Platts Crude Oil Marketwire of the mean of Dated Brent quotations published around the Bill of Lading date (BL Date) – i.e. the two quotations before the BL date; the BL date quotation and the two days quotations following the BL date;

• The average of five consecutive Plates Crude Oil Marketwire of the mean of Dated Brent quotations published immediately prior to the BL date;

• The average of five consecutive Plates Crude Oil Marketwire of the mean of Dated Brent quotations published immediately after the BL date;

• The monthly average of Platts Crude Oil Marketwire Dated Brent price quotations for the BL Month of Lifting (GHEITI, 2018[12]).

Box 2.9. Pricing policy for the sale of crude oil by NNPC

NNPC sets sale prices for each of Nigeria’s 26 grades of crude oil on a monthly basis. Specifically, most of the oil NNPC sells for export is valued using a widely-used formula pricing system called “official selling prices” (OSPs). Each OSP has three components:

• Benchmark. This is an average of five consecutive price quotations for Brent crude, as published by the trade periodical Platts;

• Differential. This is the premium or discount to Brent, expressed in dollars per barrel, that is supposed to reflect the market value of the particular crude grade vis-à-vis Brent. NNPC publishes a new differential once per month for each of the country’s 26 crude grades;

• Pricing Option. This feature allows a buyer to pay a small premium – usually USD 0.05 to USD 0.10 per barrel – which entitles the buyer to choose before lifting which five-day Brent quotations NNPC will use to price the cargo.

Source: (Sayne, Gillies and Katsouris, 2015[14]).

2.5.2. Use of a commodity benchmark

Transactions that take place in the market are often reported by specialised agencies (such as Platts or Argus) and are used as a basis for the determination of the benchmarks for different commodities, particularly crude oil grades. SOEs may need to determine for themselves an official selling price (OSP) for their commodity as a premium or a discount against the relevant benchmark. This determination will take into account several factors, including quality and location.

SOEs should ensure that their pricing formulas are market based and derived from publicly quoted commodity prices where available.

SOEs should be aware that corruption risks may be heightened for commodity sales where there is a lack of publicly quoted prices for the commodity, as is the case with some minerals. Many governments have concerns around their ability to value these commodities and may be losing revenue as a result.

The challenge that many SOEs are facing is linked to the fact that they usually do not sell finished products for which commercial prices are available, but they sell the raw ore or intermediate products for which reference prices are more difficult to establish. The OECD Centre for Tax and Policy Administration and the International Institute for Sustainable Development have jointly developed a practice note – Monitoring the Value of Mineral Exports: Policy Options for Governments – that sets out a framework for mineral valuation applicable to all minerals (IISD/OECD, 2018[25]). The recommended starting point is the commercial valuation of the mineral or metal, followed by downward adjustments for undesirable physical properties in the ore and upward adjustments for desirable physical properties or other valuable by-products. Optional steps relate to additional adjustments that might be made to account for specific economic circumstances (OECD Development Centre, 2019[26]).

Where there is a lack of publicly quoted prices for the commodity (e.g. lithium) SOEs can seek information from tax authorities collected from tax paying oil/mineral companies through documentation required by law or through audit activities undertaken by the tax administration. This approach requires strong information gathering power within tax administrations and the ability for tax administrations and SOEs to share information.

Although benchmarks for different commodities are more common for crude oil, institutions such as the London Metal Exchange publish daily prices for many minerals. For example, in Chile, Codelco’s selling prices are based on the London Metal Exchange daily pricing, Metal Bulletin publication and London bullion prices.

Similarly, in the Democratic Republic of the Congo, Gécamines takes into account average prices set by the London Metal Exchange and the London Bullion Market with discounts relating to quality of the commodity as well as the transportation costs in respect of the valuation of its sales of cobalt, copper and zinc (RCS Global, 2018[27]).

2.5.3. Transparency of pricing information

Pricing and the process that SOEs use to determine prices are the issue of greatest interest and concern to many third-party users of the data. Consequently, introducing transparency in respect of pricing information can be an important tool through which SOEs can reduce opportunities for corruption and public rent diversion and guard against undervaluation and mispricing.

The EITI has outlined options that SOEs may wish to consider to increase transparency around pricing information:

• SOEs may provide a full explanation of how they generally determine their selling prices;

• SOEs may provide information about how they set monthly prices;

• SOEs may provide information about how the prices of individual sales are then determined (EITI, 2017[4]).

Several SOEs disclose their pricing formulas to market participants prior to entering into negotiating with a buyer or holding a competitive selection process.

For example, in Iraq, SOMO determines its OSP based on international markets but with adjustments made in respect of a premium or a discount from the previous month’s advertised prices. The use of this OSP has brought an increased level of transparency to the buyer selection process in Iraq (IEITI, 2016[22]).

In Mexico, PMI sets out pricing formulas for each specific grade of Mexican crude oil to be placed at a specific market region within a determined pricing period agreed between PMI and buyer. Pricing formulas are based on international crude oil market quotes published by renowned international providers of energy and commodities information.

2.5.4. Pricing adjustment mechanism in long-term sales agreements

Many SOEs sell oil, gas and minerals under long-term sale arrangements, and in some cases, these agreements can exceed ten years duration. If sales prices are locked in for a significant period of time and commodity prices rise, SOEs can miss out on capturing the value from those price rises. Consequently, SOEs should include contractual mechanisms in their commodity sales agreements that provide for prices to be reviewed on a regular basis in order to reflect market value.

For example, in Mozambique, ENH enters into long-term gas sale arrangements for periods that usually exceed ten years. The gas price is adjusted using a specific price mechanism and indexations according to movements of the international market.

In Ghana, the length of some crude oil sales arrangements exceed ten years. Consequently, a provision is included in these agreements to adjust the differential based on daily published Platt’s price quotations which are assessed daily, and so to ensure that these long-terms sales arrangements seek to reflect market value throughout the life of the contract.

2.6. Drafting the contractual provisions

Box 2.10. What SOEs can do to reduce risks associated with unbalanced contractual provisions

• Develop standardised model sale agreements in order to minimise discretion in contract negotiation;

• Take the lead on drafting bespoke agreements rather than rely on agreements drafted by the buyer;

• Include pre-defined commercial terms in sales agreements to simplify the buyer selection process and to reduce opportunities for discretion; and

• Include a pricing adjustment mechanism in long-term sales agreements to ensure that prices are reviewed in order to reflect market value across the life of the contract.

Source: Adapted from (OECD, 2016[5]).

The inclusion of unbalanced contractual provisions in commodity trading transactions can result in significant revenue losses for an SOE. Opaque or unclear contractual provisions can cause confusion and also may unduly favour the buyer.

Asymmetries of information between the SOE and the buyer as well as the lack of general transparency in commodity sale transactions constitute major risk factors for corruption.

Red flags that may indicate unbalanced contractual provisions include: unusual long-term repayment periods and payments in open credit where there is no financial guarantee (i.e. where the SOE assumes substantial risks of default). If these risks are identified, further scrutiny is recommended for this particular commodity sale transaction.

SOEs should develop model sales contracts or templates for use in all commodity transactions with buyers. These model contracts should be developed in advance of entering into negotiations with a buyer or holding a competitive selection process. Standardised model contracts can also reduce discretion in commodity transactions as many aspects of the contract will not be subject to negotiations.

If a model contact is not appropriate in a specific commodity sales context and a bespoke agreement is required, the SOE should take the lead in drafting that agreement rather than the buyer.

In order to simplify the buyer selection process and to reduce the opportunities for discretion, SOEs can include pre-defined commercial terms in their sales agreements.

The use of specific Incoterms in contractual provisions can also have an effect on the balance of the contract as they determine which party assumes which costs and which risks. Incoterms are pre-defined commercial terms published by the International Chamber of Commerce (ICC) that are commonly used in both international and domestic trade contracts.

Incoterms inform sales contracts defining respective obligations, costs, and risks involved in the delivery of goods from the seller to the buyer. The inclusion of Incoterms in a contract allows for the allocation of costs, risks and the transfer of title between the seller and the buyer. These can include loading, export clearance, fees, insurance, unloading and transportation cost from the arrival port to destination.

Several SOEs surveyed by the OECD Development Centre in 2018 reported the use of such pre-defined commercial terms. In respect of SOEs selling crude oil, the most commonly used Incoterms 2010 is Free-On-Board (FOB).