Scoping the capital

budgeting implications of

local content development

legislation

Centre for Energy, Petroleum and Mineral Law and Policy

University of Dundee

Dr Ayodele Asekomeh

Evidence from new adoption countries

(e.g., Nigeria and Ghana)

What is “local content”?

Local Content and FDI in perspective

Some background…

Capital budgeting implications

Research Questions

Research Approach

The Issues

Prognosis

Content/Outline

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Definitions

Value added activities taking place within a

resource producing country (Neff, 2005)

When a foreign company makes products in a

country, the materials, parts etc. that have been

made in that country rather than imported. A

minimum level of local content is sometimes a

requirement under trade laws when giving foreign

companies the right to manufacture in a

particular place (FT Lexicon, 2012)

What is “local content”?

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Definitions (cont’d)

Value contributed to the national economy

through expenditure on goods and services

(indirect economic impacts and multiplier effects)

(Warner, 2010)

Last definition highlights the link between

Foreign Direct Investment (FDI) and local

content (LC) and the intended objectives of local

content legislation

What is “local content”? (cont’d)

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FDI is positively correlated with growth and

technical progress through the ‘contagion’ or

‘spill-over’ effect (Findlay, 1978; Lim, 2001)

However, FDI could negatively affect domestic

firms – reduced market share and reduced

capacity utilization (Harrison, 1996)

Local content legislation creates restrictive

conditions designed to compel domestic growth

or uptake of FDI-related spill-over effects or

regulate FDI (Qiu and Tao, 2001)

Local Content and FDI in

perspective

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However, local content restrictions may mean

that FDIs attracted are of the type that offer less

opportunities for development through contagion

(Moran, 1998)

Two reflective questions

• Before imposing restrictive conditions through local

content legislation, do policy makers fully consider

contextual differences and potential unintended

consequences?

• To what extent does local content legislation infringe

the WTO’s TRIMs agreement? (Note exception made

for developing countries)

Local Content and FDI in

perspective (cont’d)

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Several solutions proposed for the “resource

curse” – the paradox that resource-rich countries

end up being more impoverished by the

exploitation of such resources than without them

Predominantly, these involve adopting policies

used by countries that have deployed resources

sustainably, e.g.:

Development of the UK oil industry (a steep

learning curve from limited local equipment and

services)

The Norwegian Model; Trinidad and Tobago

Some background…

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However, ‘direct’ adoption of such models often

ignore contextual differences e.g., risk tolerance,

institutional quality and political competition

(Nolan and Thurber, 2010; Thurber et al., 2011)

– see chart for illustration.

A review of the Nigerian (2010) and Ghanaian

(2009) Local Content Acts indicates:

Focus on policies intended to stimulate domestic

macroeconomic growth with favourable

microeconomic conditions for local operators

Little consideration for microeconomic choices of

international operators or IOCs

Some background…(cont’d)

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Some background…(cont’d)

9

Contextual differences and suitability of role-models

(Source: Thurber et al., 2005)

How do/would IOCs treat LC provisions from a

capital budgeting perspective?

Hypothesis #1:

International operators would modify planning

assumptions to reflect increased risk and “difficult”

business environment

In what ways and to what extent would LC

legislation alter the investment decisions of

IOCs?

Hypothesis #2:

FDI decrease would not be compensated for by

increased domestic activity

Capital budgeting implications –

Research Questions

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One or a combination of:

Survey of IOCs operating in countries adopting

LC

Survey analyst and reviewers of IOCs’ financial

information

Review of relevant IOC financial statements

Develop sensitivity models to test how IOCs will

react or are reacting to the provisions

Assess long-term impact/success or otherwise

of the local content legislations

Capital budgeting implications

(cont’d) – Research Approach

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Costing of inputs;

Financing (securing

project finance with

domestic banks);

Contractual issues and

“locked-in” terms re

global supply chain

partners and providers;

Quality issues;

Project management

constraints;

Perceived risks

Compliance and

reporting costs e.g.,

submission of Nigerian

Content Plan;

Preferential treatment;

quotations and

competitive bidding

(margin determination;

game theory?);

Contribution to Local

Content fund: what

benefit?

Capital budgeting implications

(cont’d) – The Issues

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Limited success of local content programmes in

fostering long-term development

Emergence of some dominant local players

(state-backed monopolies?)

Monitoring issues (effectiveness of LC

monitoring board)

Myers’ (2005) notion [that partnership between

producers and consumers to promote energy-

efficient non-oil-based industries in low-income

producers would be a quid pro quo for secure

energy markets] would be constrained

Capital budgeting implications

(cont’d) – Prognosis

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Findlay, R. (1978), “Relative Backwardness, Direct Foreign Investment,

and the Transfer of Technology: A Simple Dynamic Model,” Quarterly

Journal of Economics, vol. 92, pp. 1-16

FT Lexicon (2012) – Definition of Local Content

http://lexicon.ft.com/Term?term=local-content) – accessed 24 April 2012

Harrison, A. (1996), “Determinants and Effects of Direct Foreign

Investment in Cote d’Ivoire, Morocco, and Venezuela,” in Industrial

Evolution in Developing Countries, ed. By M. J. Roberts and J. R.

Tybout, New York: Oxford University Press

Lim, E-G. (2001), “Determinants of, and the Relation Between, Foreign

Direct Investment and Growth: A Summary of Recent Literature,” IMF

Working Paper WP/01/175

Moran, T. (1998), Foreign Direct Investment and Development: The New

Policy Agenda for Developing Countries and Economies in Transition,

Institute for International Economics, Washington, D.C.

Myers, K. (2005), “Petroleum, Poverty and Security,” Africa Programme

Briefing Paper AFP BP 05/01, Chatham House

References

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Neff, S. (2005). Memorandum on International Best Practice in

Development of Local Content in the Energy Sector, available at:

http://www.neiti.org.ng/sites/default/files/page/uploads/local-content-5-9-

051.pdf

Nolan, P. A. and Thurber, M. C. (2010), “On the state’s choice of oil

company: risk management and the frontier of the petroleum industry,”

Stanford Program on Energy and Sustainable Development, Working

Paper #99

Qiu, L. D. and Tao, Z. (2001), “Export, foreign direct investment, and

local content requirement,” Journal of Development Economics, vol. 66,

pp.101-125

Thurber, M. C., Hults, D. R. and Heller, P. R. P. (2011), “Exporting the

‘‘Norwegian Model’’: The effect of administrative design on oil sector

performance,” Energy Policy, vol. 39, pp. 5366-5378

Warner, M. (2010), “Are Local Content Regulations a Pathway to

Competitiveness or a Road to Protectionism?” Local Content Solutions

References (cont’d)

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