The concept of the obsolescing bargain was coined by Harvard economist, Raymond Vernon, in the year 1971 and essentially connotes a shift in the bargaining power from an investor, in favour of a host government. According to Vernon, the theory of the obsolescing bargain forecasts that the passage of time will lead to the loss of an investor’s (especially the multinational’s) bargaining power v iz-a-viz, a host nation.
In international (energy) investment law, the situation is usually such that, an investor, at the start of an investment, faces high risk and uncertainty of success and is awarded a premium such as a fabulous rate-of-return to reflect the risk factor and to incentivise investments. Such incentives could include fiscal and tax incentives such as tax holidays and such other similar sweeteners.
At the crux of this theory, is the suggestion that the leverage of an investor during the life cycle of an investment shifts in favour of the host nation. At the beginning of the negotiation phase, the terms are in favour of the investor, whom the host nation will try to ensure the most favourable terms for. However, this changes negatively, as the life cycle of the investment matures. As the level of investment and the amount redirected to the host nation increases, the level of commitment and the bargaining power of the investor steadily declines.
In practical reality, and as Vernon suggested, once the investor (particularly a multinational) has sunk its costs, risk capital and assets in a developing or less developed country, its susceptibility instantly increases. In fact, where the investor's operations are now very profitable, the passage of time then reduces the government's appreciation of the up-front risks assumed by such an investor at inception. The government now places little or no value on entry risks and the risk capital already sunk by the investor. As a result, the multinational investor, in particular, may be perceived as earning unduly high returns.
Besides, with time, the host government's buoyancy improves, and with improved local infrastructure, its dependence on multinationals decreases. This then occasions a reduction in the perception of value generated by the investor. Finally, the government may be prompted by political and other considerations into reducing the investor’s (particularly where it is a multinational) gains, in a bid to assert or demonstrate its independence from foreign influence.
What typically happens is that a host country requires huge capital investments in a particular sector of its economy (the electric power sector for example) and would require foreign (or indeed private sector) investments; typically in the energy sector. To attract such investors with deep pockets and technological capabilities, the government enacts legislation, issues letters of comfort and enters into contracts with provisions which attracts would-be investors. Upon negotiating on very attractive terms, an investor, particularly the typical transnational corporation begins sinking costs by either providing or upgrading available infrastructure or facilities. It also begins to incur huge costs with the hope of generating returns after some years, considering the long lead time of energy projects.
With time, in countries that practice the dominial system of ownership of resources and utilities, the government begins to feel that the premium on the return on investment originally offered to induce investment is inherently unreasonable and will seek the renegotiation or forceful change (through legislation and such other similar means) of the terms of the original contract which significantly reduces the return on investment available to the operator.
In essence, the bargain between the State and private sector obsolesces with time.
Putting this into context, the reality of obsolescing bargain has been mostly unfavourable to investments in the Nigerian power sector, and indeed globally. And there have been several means adopted in different regions to combat the negative effects of the obsolecing of investments by investors.
As a result of the lack of bargaining power that obsolecing bargaining provides investors, a number of strategies have been developed to ‘tie the hands’ of host countries. One of such is by drawing up air-tight contracts signed between the investor and the host nation.
Ideally, such contracts would be instruments, that are able to adopt the change in macro and micro economics of the different host nations. However, the essence of contracts is to delineate the roles and responsibilities of both parties. For the energy sector, these different terms would be drawn up in the Power Purchase Agreement (“PPA”). These agreements would negotiate crucial factors such as fuel pricing, gas supply, price fixing etc; and would also set in stone the regulatory conditions for operation of the investor in the host nation.
Another crucial means adopted would be to partner with local political insiders and partners, who have an understanding of the local terrain, and are able to influence governmental and political climates to suit the needs of the investors.
Payment security arrangements between the investor and the host nation are also crucial to ‘tying the hands’ of these governments. These security arrangements include sovereign guarantees, corporate guarantees, escrow agreements and letters of credit, which would be adopted as conditions to the entry of investors to these host nations.
Provisions which offer offshore dispute resolution are also favourable to investors, as it guarantees the position of parties in the event of all disputes that arise in the life cycle of the investment.
These risk engineering mechanisms may be adopted in a bid to ensure the risks and uncertainties of unknown terrains are mitigated.
The Obsolescing Bargain and the Nigerian Power Sector
The Government of Nigeria (“Government”), for example, has stated that, to meet the country’s vision of becoming one of the World’s leading economies by the year 2020, the country must have an available generation capacity of 40,000MW. To achieve this target, the country is estimated, according to the government, to require investments in power generating capacity alone of at least US$3.5 billion per annum for the next 10 years.
Correspondingly large investments will also have to be made in other parts of the supply chain (i.e. the fuel-to-power infrastructure and power transmission and distribution networks). Considering the various issues Government is contending with, the Government, cannot fund this very important sector and has, therefore, invited the private sector both locally and internationally, to participate in the sector. Similar to our opening paragraph, the Government, has incentivized the private sector to invest risk capital in the electric power sector.
Indeed, the Minister of Power, Works and Housing has reiterated the favorable environment created and maintained for long term sustainable investment in the Nigerian power sector, and this has encouraged foreign and local investment across the spectrum of the Nigerian energy mix.
Unlike what the theory proposes, the Nigerian power sector continuously provides incentives for the investor in this sector. Some of these include the grant of pioneer status as a tax holiday for 3 – 5 years; access to development loans and grants and the unwavering support of the Federal Government in meeting its goals. In the Nigerian economy, one cannot outrightly suggest that the balance of power shifts absolutely in favour of the Government, once investment reaches local soil.
What is more prevalent, especially in the power sector, are joint ventures between state owned enterprise and foreign investors, in providing solutions to energy needs. This has been seen in the most recent developments of hydro power and solar power.
Indeed, as the level of investment of a foreign investor increases in the Nigerian power sector, the rate of return is bound to increase as a result of economies of scale. The more entrenched a particular investor or multinational company is in the Nigerian space, the greater leverage it may have over the economic trends in that particular sector and the ability to benefit from expertise in that sector. Negotiating leverage would therefore naturally be on the increase, and inevitably, the hands of the host nation are tied to meet the demands of the benefactor.
Example can be seen with Millhouse Generation Services Limited, Shoreline Power, Clarke Energy Nigeria, which are multinational companies set up in the Nigerian power sector. These companies have been able to entrench their operations and thus benefitting from widespread economies of scale.
It is crucial to note that there will always be ample opportunities for host nations to take advantage of the presence of multinationals, and begin shifting the balance of power back in favour of host nations. However, it is crucial for such investors in the power sector to take advantage of these risk engineering tools outlined above, in ensuring the rebalance of power in their favour.
Unfortunately, the Nigerian power sector has not experienced self sufficiency with regards to the power sector, and thus relies on investment, both local and foreign, in boosting capacity and maintaining steady generation of power. Based on these, the presence and favour of investors is still encouraged, and the Government cannot afford to shift bargaining power completely in its favour.
Beyond Obsolescing Bargain?
Recently, it has been a widely held view that the obsolescing bargain has outlived its usefulness because host country governments rarely negotiate entry conditions, and usually provide conditions precedent to investment in a nation.
However, we consider that the theory does have long term usefulness as it can be restated more broadly as a political bargaining model where investor relations and negotiations take the form of political bargains with different host nations, for the most favourable conditions for entry and maximizing returns. And therefore, in this form, it still very much exists in most host countries seeking investment in the power sector, and in all sectors.
We believe the risks of the obsolescing does exist, but are convinced that Nigeria and the electric power sector in particular will be exceptions to that rule. No government will forfeit complete control of its power sector, to investors, be they local or foreign; however the Nigerian power sector has grated ample opportunity for all participants and investors to entrench operators and reap systemic rewards.