CHAPTER 12 RISK MITIGATION IN INTERNATIONAL PETROLEUM CONTRACTS

• Jurisdiction: Derecho Internacional

International Mining and Oil & Gas Law, Development, and Investment (Apr 2019)
CHAPTER 12
RISK MITIGATION IN INTERNATIONAL PETROLEUM CONTRACTS
John P. Bowman
King Spalding L.L.C.
Houston

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JOHN P. BOWMAN is a Partner with King & Spalding LLP in Houston, where he is engaged in an arbitration and litigation practice representing primarily international oil companies and service companies in a wide range of commercial and investment disputes. He is a frequent writer and speaker on international arbitration and international oil and gas topics. He is a Past President of the Association of International Petroleum Negotiators (2014-2015) and a former member of the governing Council of the Texas State Bar Oil, Gas and Energy Resources Law Section. Increasingly, he is called upon to assist IOCs and international NOCs design, draft, negotiate, and assess stabilization mechanisms and dispute resolution provisions in upstream and project agreements with host governments and NOCs. Mr. Bowman is an Adjunct Professor for International Arbitration at the University of Oklahoma College of Law and for International Energy Arbitration at Georgetown University Law Center. The Inter-American Commercial Arbitration Commission recognized Mr. Bowman for his contribution to education concerning the Panama Convention at its conference in Panama City celebrating the Convention's 40th Anniversary in May 2015. Mr. Bowman is a member of the Advisory Boards of the Institute for Transnational Arbitration and the Institute for Energy Law. He is a Fellow of the College of Commercial Arbitrators and of The Chartered Institute of Arbitrators. He received his J.D. from the University of Kansas School of Law in 1980, where he was Editor-in-Chief of the Kansas Law Review.

I. INTRODUCTION: CONTRACT STABILIZATION STRATEGIES

From the earliest Middle East concessions to today, international oil companies ("IOCs")¹ have frequently required host governments to provide stabilization assurances before agreeing to risk their capital, time, and talent in a large-scale investment. The famous Agreement of May 28^th , 1901, between the Shah of Persia and William Knox D'Arcy declared: "All lands granted by these presents to the concessionaire [or] that may be acquired by him . . ., as also all products exported, shall be free of all imposts and taxes during the term of the present concession."² The first book devoted to government guarantees to foreign investors expressed the need for stabilization guarantees this way:

The guaranteeing states have to commit themselves as to the future, to promise that certain measures are not going to be taken, that certain others will continue to be taken, or that the investor will be compensated for any loss due to changes in such measures. Foreign investors have to be assured that they will receive, both today and in the future, a definite legal treatment, specified in the relevant legal instruments, and that consequently they need not fear any major changes in local legal or political conditions that would be unfavorable to their interests. ³

Fast forward to 2014, the CEO of the Malaysian state oil company Petronas warned the British Columbia provincial government that Petronas was ready to call off a $10 billion LNG project in western Canada because of delay in project approvals, a new LNG tax, and lack of appropriate incentives to develop the industry. According to the Petronas CEO, "Rather than ensuring the development of the LNG industry through appropriate incentives and assurance of legal and fiscal stability, the Canadian landscape of LNG development is now one of uncertainty, delay and short vision."⁴

An effective system of contract stabilization requires three elements: stabilization clauses in the host government contract, choice of law which "internationalizes" that contract or restricts application of the host country's law, and agreement on international arbitration to resolve future disputes.⁵ These three elements "lean on" each other - they are correlative - and together they

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form a robust "stabilization architecture."⁶ Two other sources of contract stability sometimes come into play through stabilization assurances in the petroleum or investment law or a project-specific decree⁷ and through investment protections granted foreign investors under applicable bilateral and multilateral investment treaties. The exact combination of these elements varies from country to country, contract to contract, and project to project, as host government willingness to grant stabilization assurances changes over time and ultimately depends on several factors that influence the strength of government desire for private investment.

Host governments offer contract stabilization for a variety of reasons. First and foremost, they offer stabilization to attract investment. "Developing countries accept stabilisation clauses in order to gain an economic advantage in attracting foreign investment in the petroleum sector by making their investment climate more competitive and favourable to the foreign investor."⁸ They may be most inclined to offer stabilization to attract "First Movers" in the hope of developing a new upstream petroleum industry. As noted by one industry expert, "competition among countries with unproven petroleum potential and faced by high oil import bills had resulted, especially in the 1990s, in the framing of many 'frontier' fiscal packages, featuring special investment incentives."⁹ Writing in 1995, Dr. Chakib Khelil, then with The World Bank and soon to become Algerian Minister of Energy and Mines and President of Sonatrach, noted that governments responded to market forces in setting terms and conditions, but that they set these terms and conditions primarily on a regional basis for two reasons. "First, some governments, particularly those of smaller countries, have limited information about fiscal terms and conditions around the world, but usually have better knowledge of the terms in neighboring countries. Second, it is often difficult for governments to defend terms and conditions significantly more favorable to foreign oil companies than those set by their neighbors."¹⁰ Host governments may be most likely to offer contract stabilization commitments during periods of low petroleum prices.¹¹ But Kenneth Dam

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probably described the most compelling reason that governments give, or should give, stabilization incentives in his discussion of the auction method for allocating petroleum licenses in his book on Oil Resources: Who Gets What How?: "By affording greater protection against state repudiation, the state will not merely receive higher bids, but will also extract more of the economic rent. Indeed, a condition of extracting all of the economic rent through an auction would be absolute protection against state repudiation."¹²

For their part, IOCs request and in some cases demand contract stabilization for at least four reasons. First, stabilization clauses in host government contracts deter adverse government actions. Second, these provisions promote negotiated resolution of disputes when governments, despite the deterrent power of these provisions, exercise their legislative and executive competence to diminish the value of contract rights unilaterally.¹³ In this situation, these provisions mitigate investor losses. Third, international arbitral tribunals enforce stabilization commitments freely granted by host governments unless the investor entered into an equivocal or illusive stabilization commitment or waived its stabilization rights by acceding without protest to government demands for contract revisions or by making a tactical decision not to aggravate an already fraught host government relationship by invoking or pursuing its stabilization rights.¹⁴ Last, the presence of stabilization clauses reinforces host country obligations under investment treaties by providing strong documentary evidence of the investor's legitimate expectations when entering into the investment agreement or by triggering a right under some investment treaties to expand protections to tax or other areas otherwise expressly carved out from the treaty protections.¹⁵

II. STABILIZATION PROVISIONS IN HOST GOVERNMENT CONTRACTS

A. Types of Contract Stabilization

Stabilization clauses seek to protect the investor from governmental action that adversely affects the value of the investment contract, and underlying investment, by preventing that action,

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by insulating the contract from the action, by shifting to the host state or NOC the financial burden of that action, or by modifying the terms of the contract to restore all or part of the contract's original value in response to that action.¹⁶ A review of stabilization provisions in host government laws and contracts reveals ten main types:

1. State guaranties of stability;

2. Exemptions from taxes and other fiscal obligations;

3. Clauses that "freeze" applicable law, typically by incorporating by reference a specific vintage or subset of laws;

4. Clauses that "freeze" contract terms by according them "enclave" status, either expressly in the form of "inopposability" provisions or indirectly in the form of "intangibility" provisions;

5. Allocation of risk clauses, by which the host government or NOC agrees to bear fiscal risk as its "area of responsibility";

6. Renegotiation clauses that provide a contractual mechanism to modify the investment contract in response to a change in law and/or a change in circumstances;

7. Clauses that require the host government to adopt the contract as the "law";

8. Clauses that "contractualize" governing law by repeating its terms in the contract as an obligation of the host government or NOC;

9. Anti-expropriation clauses; and

10. Anti-stabilization nullification provisions. ¹⁷

Frequently, a host government petroleum contract contains multiple forms of contract stabilization that...