CHAPTER 4 RESOURCE NATIONALISM, EXPROPRIATION, AND CREEPING EXPROPRIATION AFFECTING THE EXTRACTIVES SECTOR

• Jurisdiction: United States

International Energy and Minerals Arbitration
(Sep 2013)
CHAPTER 4
RESOURCE NATIONALISM, EXPROPRIATION, AND CREEPING EXPROPRIATION AFFECTING THE EXTRACTIVES SECTOR
Elisabeth Eljuri ^*
Partner, Norton Rose Fulbright
Caracas, Venezuela

ELISABETH ELJURI is the Head of Latin America of the global firm Norton Rose Fulbright. She is also one of the firm's senior partners in natural resources as well as international arbitration. Elisabeth received her law degree from Universidad Católica Andrés Bello and an LLM from Harvard Law School. She is admitted to practice in New York and Venezuela. In Latin America, Ms. Eljuri focuses on corporate and transactional work involving high-end sophisticated transactions for Fortune 500 corporations as well as international dispute work related to major energy and mining projects and infrastructure. Over the past two decades, she has advised oil and gas companies and mining companies engaged in high level transactions as well as international disputes. Major deals she has handled include acquisitions of hydrocarbon companies and producing areas, a crude oil storage and ship loading project, two of the world's largest gas injection projects, a major coal project, and several acquisitions of major mining projects. She frequently acts as counsel in international arbitrations, including ICC and ICSID procedures and has experience in domestic investigations under the FCPA and European anticorruption legislation. She also acts as expert in major arbitrations in the field of natural resources. Elisabeth is President of the Association of International Petroleum Negotiators (AIPN) based in Houston. She is considered a leading natural resources and energy practitioner in the Latin American Region and has published extensively in this area. In 2012, Who's Who in Oil and Gas again selected Elisabeth as one of the top 10 energy practitioners worldwide as did Who's Who in Commercial Arbitration. Likewise, Chambers ranked Elisabeth as one of the top 20 energy lawyers in Latin America and Star Individual for Venezuela as does Legal 500. Legal Media Guide listed Elisabeth among the top 25 Natural Resources and Energy Lawyers in the world.

Resource Nationalism, Expropriation, and Creeping Expropriation Affecting the Extractives Sector

Elisabeth Eljuri

Head of Latin America, Partner

Special institute on International Energy and Minerals Arbitration

Toronto September 16-17, 2013

Presentation Outline

• Political risk in the natural resources sector

• The obsolescing bargain

• Resource nationalism vs contract sanctity

• Types of political risk

• Expropriation and similar government actions

• Contract risk

• Restrictions on arbitration

• Mitigating political risk

• Stabilization, allocation of risk and adaptation clauses

• Other contractual provisions

• Political risk insurance

• Bilateral investment treaties

• Conclusions

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• There are general risks present in any hydrocarbon or mineral-rich jurisdiction

• The common goal of the host government and the private oil and gas company or mining company is to increase the "size of the pie" and ensure that each gets their fair share of such pie

• Ernst & Young's 2013-14 Business risks facing mining and metals report (released in June 2013), says the risk of resource nationalism remains "every bit as critical as it was last year."

• The report also says "in some respects, companies are becoming less sensitive to the shock of resource nationalism . . . (as it) has become more endemic, mining and metals companies have become better at managing this risk."

• The Problem of the "Obsolescing Bargain":

• When does it arise? When the government no longer gets its fair share or at least perceives that

• In such cases, the government soon becomes dissatisfied and the contract will come under pressure

• Interestingly, this may occur regardless of the political views of the State

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• The "obsolescing bargain" is used to describe the change in bargaining power in favor of the host state that occurs once a project sponsor, initially encouraged by a host state to invest, has committed its capital

— An investor, at the start of an investment, faces high risk and uncertainty of success and is awarded a premium in terms of, for example, rate-of-return which reflects this

— Once the majority of the investment is sunk and the investment is successful, risk declines, often substantially, and the host government seeks to renegotiate the level of return in its favor - to the disadvantage of the investor who, in consequence, suffers a loss compared to the original terms

• Petroleum Expenditure & Revenue Profile

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• When is the Original Bargain Made?

• When is the Original Bargain Obsolete?

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• State & Investor Tension

• Preventing the "Obsolescing Bargain" Problem:

• There need to be credible threats or incentives or both ("sticks") to enforce a stable fiscal and legal regime, such as:

— fiscal and legal stability guarantees

— international arbitration mechanisms to enforce performance of these guarantees

• Better still, prevent the problem from occurring by using "carrots":

— creating alignment between the State's objectives and the investor's investment incentives

— establishing a fiscal regime that is durable across a broad range of revenue and cost environments

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• Host governments also want to ensure:

• Full and prompt exploration of prospective areas,

• Protection of the environment,

• Proper treatment of residents and communities affected by development,

• Training and education of citizens,

• Purchase of local goods and services, and

• Reasonable controls over development activity.

• Natural Resources projects are:

• unique, involving investors and host states

• capital intensive

• long-term, fixed investments -quasi-irreversible

• vulnerable to resource nationalism

• Resource nationalism vs contract sanctity

— ideological agendas

— domestic political considerations

— geopolitical tensions

— greater claims to natural resources

— reversal of trends, or mere cyclical progression?

[Page 4-7]

Types of Political Risk

• Two typical sources of risk: instability and deliberate actions

• Expropriation: Government taking of private property for administration by the public sector (usually lawful but compensation is due)

(Is there is difference with nationalization? Confiscations?)

• Two basic types of expropriation:

• Direct - may be whole or partial

• Indirect - gradual erosion of investor's stake (creeping expropriation)

• Contract risk:

• Contract breach and repudiation

• Forced renegotiations

— Coercion, duress and undue influence

— Multiple means by which this occurs

• Restrictions on arbitration such as:

— denunciation of international conventions

— termination of BITs

— threats for those who resort to arbitration

— withdrawal from ICSID

• Consequence: Chilling effect on international investment

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• Stabilization and Freezing clauses

• Aim to 'freeze' the contractual legislative and regulatory environment pertaining to the investment

• Most effective in thwarting creeping expropriation

• Issues regarding the ability of a state to curtail its own sovereignty

• Allocation of risk clauses (an indemnity for governmental measures)

• Adaptation clauses (right to renegotiate)

• Maintain economic benefits of investor where the operating environment changes

• May be less susceptible to breach or repudiation due to their private law nature (ideally, should give rise to arbitration)

• Other contractual provisions:

• Penalty clauses (liquidated damages)

• Unrestricted access to international arbitration

• Sovereign immunity waivers

• Parent company guarantees

• Letters of credit and other security

• Practical considerations, such as:

— Being aware of the host state's attitude to sanctity of contract

— Enforcement procedures and enforceable assets

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• Political risk insurance

• Not always available

• Public and private providers

• Increasingly covers developing and emerging markets

• Public PRI providers

— Over $220 billion in over 4,000 projects in developing countries

— Comprise both national and multilateral institutions

• Private PRI providers

— Berne Union - covered $1.8 trillion worth of business in 2011, approx. 10% of world trade

• Application of PRI

• Useful only where political risk has high impact but low probability

• Limited effectiveness where government interference is minimal

• Should only be considered as a last resort to address residual risk

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• Availability of Bilateral Investment Treaties (BITs)

— Both the ICSID Convention as well as BITs have been under attack by countries who are strong on resource nationalism

• Investment structuring under BITs

— Protection for investors when expropriation or similar actions take place

— Usually provide access to international arbitration

— Uniform and common rights include fair and equitable treatment, full protection and security, most-favoured nation clauses and umbrella clauses

— BITs have served as avenue for invocation of 63% of ICSID claims

• Treaty planning/shopping

• Intentional selection of BIT of host state and third party country

• Accounts for variable nature of individual BITs

• Two potential approaches:

— Back end: organizing affairs once dispute has arisen (not covered)

— Front end: organizing affairs prior to dispute arising (much more solid)

• Certain tests need to be met:

• Effective management or actual control, as opposed to mere 'nationality'

• Importance of definitions of 'investment', 'investor' and 'nationality'

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• Final remarks on treaty planning

• Long-term natural resources investments and projects should fall within definition of 'investment' in most treaties

• Particular consideration should be paid to...