Legal Aspects of Oil and Gas Management Essay Sample

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Legal Aspects of Oil and Gas Management

Concerned of any future policy reversal measure that may put at risk the terms of investment agreements, investors in the oil sector often seek guarantee, contractual or otherwise. The need to address such fears thus saw the proliferation of stabilization clauses in the oil and gas contracts. These clauses are believed to maintain the stability of the terms that were originally agreed upon. In particular, the fiscal regime aspect of the agreement is at the heart of such clauses. The clauses provide a bulwark against a host nation (unilateral) reviewing the initial contract agreement terms through an administrative or legislative action. The clauses are of high value particularly to foreign investors, host nation, and various stakeholders within the oil and gas industry. The clauses seek to reaffirm the parties’ belief in assurance and sanctity of contract terms will outlive the host government which was actively involved in the creation of the agreements while safeguarding the existence of and profit benefits of the investor. This application is in addition to offering solution base and consensus in future standoffs and disagreements that may appear between the parties.

Stabilization clauses have a long history of application in various sectors, especially in the gas and oil sector. Delloite (2014) traces their origin to the period between the first and second World Wars. At this period, US international companies began including these clauses in the concessionary agreements between them and host states as a result of Latin America’s nationalism. Within the oil and gas industry, the stabilization clauses create specific commitments that bar the host state from altering the agreement terms without the consent and comprehensive consultation with the other contracting (Margarita, 2003). However, there are perceptions by host states that these international companies make huge benefits from the high energy prices and have in the recent past unfairly benefited from the initial terms of the production sharing agreements (PSA’s) and the subsequent soaring of oil prices which has led to various host nations seeking to alter and repudiate fiscal regimes (Emeka, 2008). To counter this step, investors have come up to defend themselves citing the colossal risks that they undertake in exploring new frontiers, unrecoverable costs, dry hole scenarios, and the volatile nature of gas and oil prices. This paper will evaluate the function and aims of stabilization clauses and comment on how they seek to achieve the stability that parties desire.

Recent fluctuations in petroleum and petroleum products prices, which in most cases is in the upward, and the apparent rise in profits to these companies as a result of the increase often attracts the interest of reviewing initial terms from the host nation. According to Abdulla (2006), this has recently been the most common trigger of tension between the two principals with the host determined to make adjustments to the initial payment agreement (IPA) in response to the changed circumstances as well as political pressure. Notably, investors’ objective to recoup reasonable returns relative to their investments over short timespans drives their quest for stability in the fiscal as well as legal terms. Confiscatory measures are known to exist which “interfere with the investors’ rights” including other considerations regarding financial as well as non-financial attributes affecting the investors (Delloite, 2014).

Additionally, international oil and gas investors are keen to anchor PSA terms on the legal regime with the host states effected at the time of investment (Margarita, 2003). They ensure predictability since it is one of the critical concerns during the formulation of these clauses and in ensuring the investors reap reasonable returns. Comprehensive stabilization clauses often bar the host nations from amending legislation or applying any amended legislation which has the potential to impact investment. According to Delloite (2014), current stabilization clauses outline the various needs for reinstating legislation to the prior balance of benefits especially economic-related and in the case of adverse legislative changes rather than restraining the host states from implementing the amended legislature.

Stabilization Clause Tools

Contractual, bilateral, and treaty-based stabilization tools are mechanisms that an investment utilizes present in international investment instruments like multilateral and bilateral investment treaties. These agreements often occur between two nations of different economic states mainly a developing and a developed nation. A bilateral clause seeks to offer procedural and substantive protections to the investor originating from one of the states. Consequently, this treaty allows investors to initiate any claims of arbitration against the other (host) nation without necessarily relying on its home state during the prosecution claim (Delloite, 2014). The consequences of the existence of the two principals in this case and their potential for enforcement rely on these bilateral treaties. In case the host develops policies that threaten the working conditions of the investor, then the investors can defend themselves according to the obligations that the host state agreed upon prior to investment. In case a foreign investor breaches, then the host state has the mandate to consult the other state which can lead to consequences such as potential changes in policy aimed at settling the dispute (Waelde, 1994).

Clauses’ role in stabilizing both parties

It is necessary for international oil companies to carry out a comprehensive due diligence regarding the host nation’s socio-economic, legal, fiscal, geological, and political environment prior to committing investment in the oil and gas business (Abdulla, 2006). Additionally, they should lay out parameters for commercial viability appraisal of the venture as a result of the crash between the international oil companies and the host states due to their divergence (Waelde 1994). This divergence is often in the aftermath of the views of the two principals where the host nation is interested in revenue maximization while the international company is more interested in maximizing its profits. However, these companies seek risk mitigation tools in their exploration and exploitation projects against a future occurrence that may arise on a state reviewing the initial terms of the agreement (Emeka, 2008).

Foreign investors often protect themselves by ensuring that international laws override the local laws of host nations in matters investment. The occasional conflict between these two sets of laws often involves stabilization and sanctity of contract on one hand, and sovereign prerogative and freedom contract on the other. Host nations often seek to settle disputes within their laws and courts against the wish of these foreign investors. In order to guard themselves against host nations exploitation and local laws jurisdiction, foreign companies seek a choice of law and occasional forum provisions while inserting various stabilization clauses within the agreements (Likosky, 2009). With this regard, they attain the ability to have their disputes settled within more investor-friendly and independent international tribunals. The use of these stabilization clauses is mainly to freeze the host state laws which might apply to their contractual agreements or relationships by rolling back to enforcement of the laws that were in force during the contract negotiations.

Foreign investors have in the recent past benefited from the inclusion of these clauses and the rule of independent tribunals. One of the notable beneficiaries is the Texaco Company in its dispute with the Libyan Government where it was won a suit challenging the Libya Government’s attempt to change the operational terms (Likosky, 2009). Many reviewers and researchers have taken sides with the investors by justifying their quest by arguing that when a host government irrevocably deprives a foreign investor of its contractual rights within a joint venture that was created under investment agreement then the “interference will give rise to a right of compensation” (Muchlinski, 1995, p. 501).

Additionally, the tribunals oversee how the negotiations should be carried out. Regarding these guidelines, the negotiations process often considers the original agreement. A notable scenario is the AMINOIL case where three Arab States sought to review the revenue share arising from the increase in the investor’s profits (Likosky, 2009). Likosky further reports that the subsequent negotiations did not bear fruits with the Kuwait Government seeking to severe its agreement with AMINOIL. However, the contractual clauses were significant in the court proceedings and were at the center of decision-making which ensured that, despite the various changes that effected, AMINOIL still preserved its growth and profitability (Likosky, 2009). The tribunal heavily relied on the original contract while determining an equilibrium that was meant to kill off the standoff that had arisen between the two principals.

In repatriation, host governments have taken steps which in some cases involved a total replacement of past laws and renegotiation of terms regarding the working conditions and benefits ripped in the process. Regarding these new developments, contractual negotiations, and clauses implementation have escalated recently in oil and gas-rich nations, with the host governments justifying the stiff negotiations on development grounds. However, legality issues emerge in the process thus creating a bigger wave of further negotiations and necessity to include clauses within so as to evade such negotiations in future. In Bolivia, for example, the National Government in 2006 passed law 3058 on hydrocarbons which replaced the 1996 version that privatized the hydrocarbons sector (Likosky, 2009). With these changes, it moved to control the oil and gas resources while taking back the control to the state. However, it is evident that the lack of concrete national expertise is likely to guarantee foreign companies future roles. Despite the cancellation of contracts by the 2006 law, AFX (2006) reports that it created a wave of negotiations over new contracts with terms that better favored the government while imposing higher royalty fees and tax in line with the higher oil prices.

Similarly, the Ecuadorian Government set off a policy that required contract renegotiation aimed at increasing its revenues (Kerr, 2007). In line with the change, Kerr reports that foreign companies, particularly Occidental, took action regarding the demands by the government to pay additional value-added taxes. Further, the government ensured that the future investments must be made through Petros de Venezuela S. A which is a state-owned company established to oversee oil and gas business. The law further required that future investors be on 51 percent control by Petros de Venezuela (Dugan and Profaizer, 2007; Likosky, 2009)

Stiff standoffs have happened in the recent past as a result of host governments’ attempts to change the agreements with the oil investors. Investors have progressively renegotiated with host governments so as to safeguard their future and profit margins. In Venezuela, for example, a presidential decree expropriated Orinoco River Belt projects in 2007, setting off a wave of renegotiations (Dugan and Profaizer, 2007). According to the new requirements, Petros de Venezuela was to hold majority stakes in any of the entities present. Additionally, the decree required that any dispute was heard in line with the Venezuelan laws and by Venezuela courts. Despite these rigid standoffs, however, foreign companies advanced their renegotiations to reach a consensus that guaranteed their ventures by incorporating a joint venture with the state company in overseeing the investments. In a different scenario, oil-rich African nations, notably Chad, Equatorial Guinea, and Mauritania have sought to renegotiate various contracts and sever certain terms (AFX International Focus, 2006). However, the repulsion by various foreign companies has led to delay in implementation of government demands as a result of their demands for the inclusion of clauses that guarantee their operations and profits while safeguarding their investments from adverse interference by the governments. Additionally, a consensus on one of the sections was reached which stipulated the justification of previous negotiations and agreements with minor changes required since the governments presented needs to combat the past legacies which originated from colonialism eras. These agreements which put in place the needs of both principals often seek to enable the host government maintains their foreign corporate and financial interests while simultaneously creating terms that facilitate proper working conditions and profit margins to the foreign states.

In the above discussion, it is evident that the stabilization clauses are not only necessary to the investors, but also to the host nations. However, as a result of the continuous change in government regimes, many new governments seek to topple the initial agreements and review them to create more favor upon themselves. However, as observed in various suits discussed above, the clauses have been of great significance and offering a reference point in solving disputes especially when an independent tribunal is involved.

References

Abdullah, F 2006, ‘Validity and Efficacy of Stabilisation Clauses Legal Protection Versus Functional Value,’Journal of International Arbitration, 23(4):317-336,

AFX International Focus, 2006, Global Oil Industry Faces Broad Spectrum of Political Risk.AFX International Focus (9/19/06).

Delloite, 2014, Stabilization Clauses in International Petroleum Contracts: Illusion or safeguard? Delloite, pp. 4-10.

Doak, R 2002, International Arbitration of Petroleum Disputes: The Development of a Lex Petrolea, Rocky Mountain Mineral Law Foundation of International Energy and Minerals Arbitration Law Series. 2-18

Dugan, C and Profaizer, J 2007,Venezuela launches next stage of expropriation. Stay Current: A Client Alert from Paul Hastings.

Emeka J, 2008, ‘Anchoring Stabilizing Clauses in International Petroleum Contracts,’Int’l Law, 42: 13-17.

Kerr, J. 2007, Ecuador’s new energy minister calls for renegotiation of contracts, but not nationalization, Global Insight.

Likosky, M 2009, ‘Contracting and Regulatory Issues in the Oil and Gas and Metallic Minerals Industries,’ Transnational Corporations, 18, 1-42.

Margarita T, 2003, ‘Stabilisation Clauses in International Petroleum Transactions,’ Denver J. International Law and Policy 217.

Waelde T, & NDI G, 1994, International oil and gas investment: moving eastward? London, Graham & Trotman/M. Nijhoff.

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