Considerations for Joint Ventures.
Joint ventures (JV’s) and Joint Venture-like arrangements such as Strategic Alliance and Risk Sharing Agreements, are becoming an ever more essential part of the business landscape, with Oil & Gas companies typically tying up around 30 to 40 per cent of their portfolios in (non-operated) JV’s.
That figure will likely grow to some 70 to 80 per cent over the next five to eight years as companies enter new territories in the hope of securing resources, and are ever more dependent on local partners. Spreading risk, combining entities with differing asset and skill bases, and enabling parties to consolidate their core strategies can be very attractive benefits when entering unchartered territory.
This is particularly relevant in Africa, as international companies usually can’t access the vast resources available on the continent without finding a local partner. Most of the countries have heavily protectionist regimes and therefore laws favour (and often mandate) that local companies front or participate in major projects. This inherently means that the Western partner will have less control over the success or failure of the venture. Hence it is incumbent on companies to think carefully up front about who they will partner with, what their formal and informal agreements should look like and how they will govern the venture. Thinking through, and carefully mitigating, the barriers to successful implementation is also essential: without this up front planning there is limited likelihood of success.
When boards consider JVs they tend to think of a mutually beneficial and legally binding (and enforceable!) contract between their company, a government, national oil company or financial institution, bringing them much needed access to or licences within a host country. They foresee a straightforward arrangement with both sides keeping each other’s interests firmly in mind. A well-developed and legally sound Joint Venture Agreement (JVA) underpins this confidence.
All too often however, JVs are forced marriages between two or more parties who misunderstand each other and have widely differing aims. Western companies often lack the expertise needed to make joint ventures work in practice; they over-rely on the JVA and legally binding agreements, and inadvertently under-resource the venture itself, or pay scant attention to any warning signs that trouble lies ahead. Cost overruns, schedule delays, compliance issues, negotiations and value-erosion are common challenges faced by these types of arrangements. The signs are, though, that JVs are here to stay, driven by a clear rationale of gaining access to new markets, natural resources, labour and finance. Particularly when venturing in such politically and culturally different, and rapidly evolving, regions as Africa, prospective joint venturers would be wise to consider some fundamental lessons which can provide smoother venture performance and lead to significantly greater investor returns while limiting risk:
Legal / Political: In Africa legal contracts and JV agreements do not hold the same legal sanctity as in some Western countries and are therefore frequently adjusted, renegotiated or – in extreme cases – ignored or overridden.
Western companies tend to believe that a contract (once set up and signed) will be adhered to. However, that’s an assumption that doesn’t always hold up when it comes to working in some developing and rapidly changing African economies. Before going ahead, running challenging ‘what if’ scenarios as to how the local joint venture partner(s) may seek to renegotiate and erode value can be helpful. Playing ‘war games’ and ‘what-ifs’, using neutral third-party joint venture experts, and then putting practical, real-world defences in place help to make the joint venture a hard target and managing these defences continuously as the venture matures is key to success.
Government intervention: Where an investment attains national importance, it is not uncommon for unexpected claims to arise around compliance, environmental impact and the (re)interpretation of the JV agreement.
In some cases, political forces can change the rules of the game even after the venture is underway and substantial CapEx has been invested. JV’s, PSA’s and PSC’s for Oil and gas exploration projects in Africa, where politics are a primary concern, need to assess the likelihood and potential impact of government concessions being agreed and adhered to. They must also consider the potential level of government support, or expected intervention as the venture establishes itself and becomes operational.
One area in which this frequently plays out is in the recruitment of employees. African regimes often mandate that extremely high proportions of the workforce be local, irrespective of the availability of technically competent locals. This can mean that the JV struggles to employee technically competent people and/or is forced to use inefficient and costly employment models to work around this. For instance, IT vendors and suppliers may not be available in all territories and the management team may find local customs and preferences require them to employ many more individuals than planned.
Oil and gas projects also frequently struggle with a lack of certainty around government concessions which can change at limited notice depending on the political ‘wind’. Finally, government under-investment in an already challenged infrastructure can lead to unforeseen operational challenges.
Governance: Different standards, behaviours and traditions apply, and local knowledge is all-important
Whether you are dealing with governments, National Oil Companies or corporations, it is essential to understand the true motivation of joint venture partners, and actively manage how these motivations change over the years. For Governments granting mineral or exploration rights, for instance, International Oil Companies’ need to appreciate that their joint venture partner will want to be seen to deliver value to their electorate, whether through equity rights, resources or assistance with infrastructure projects. Periodic governance ‘health-checks’ are essential to ensure these disparate needs are reflected in the ongoing JV governance framework.
Culture: One often-overlooked facet of working in Africa is the fact that countries, and even regions within countries, can differ vastly.
Cultures, governments and working practices can vary significantly, particularly in relation to public and group meetings where personal and corporate status has elevated importance. It is often advisable to have “back-channel” support for negotiations with the respective governments to gain an accurate and realistic view of the way key decision-makers are leaning; so any venture that crosses borders will need to evaluate the behaviours prevailing in each country separately. For example, management teams may find themselves facing difficulties when ‘local hires’ question the work-attendance-level, as this is likely to be greater than those hires expected.
Corruption: Levels can be higher than in Western countries, with better safeguards required.
What one jurisdiction regards as unacceptable, for example in relation to separation of authority between business and the state, can be acceptable in another. Governance and controls can be put into place to mitigate against this but investors would be wise to assess the potential impacts (and likelihood) of corruption up front. Read more about anti-bribery and corruption in the “Protecting your business from ABC” article on page 29.
Management of off-plan performance: Plans should consider a healthy level of downside risk in case things go wrong (e.g. contractor default, CapEx overruns, delays, non-delivery of infrastructure)
Corporate governance should be designed to ensure the presence of formal mechanisms to determine and manage effective remedial action. Drilling, exploration and development are extremely capital-intensive activities. Projects often run to tens of billions of dollars. Successful ventures can be highly profitable for stakeholders, but assessment of real-world, practical risk at the outset is essential, both in terms of the planned operation and the ability of the various parties to cooperate. If a joint venture is to have any chance of success, it needs strong, practical foundations.
Cash: Cash can become trapped in the country with no clear repatriation route.
Equally, basic financial and cash management practices are frequently not adhered to. All too often we see our clients fail when trying to embed their more sophisticated ‘Western’ financial discipline and cash-management protocols within the finance function. CapEx and OpEx cost recovery is also, increasingly, a negotiation intensive activity where substantial value can be lost.
So how can you ensure your JV is a ‘marriage made in heaven’? We consider there to be four fundamentals areas to prioritise up-front planning ahead of finalising an African JV, and recommend revisiting the approach to each area on a periodic basis (perhaps annually) in order to give the JV the greatest chances of success:
Investing time or effort upfront to address these challenges can be the difference between and success and failure of the venture. Appropriate due diligence, ‘what if’ thinking and practical planning for success may seem costly in the short term, but the returns in the long term are undoubted.
The key to assessing these issues is to work back from potential failure or under delivery scenarios, as though the risks had already manifested themselves. Rigorously track back through management to understand the types of problems that may occur and the potential root causes of each. Drafting the right JV agreement is naturally important. It is equally essential (and too often ignored!) to remember that considerable value and protection can be generated by building in early detection of issues, and practical recovery capabilities as well as clear exit mechanisms.
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Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.