POLITICAL RISK MANAGEMENT IN LATIN AMERICAN NATURAL RESOURCES PROJECTS: THE TOOLBOXd1

• Jurisdiction: Derecho Internacional

International Mining and Oil & Gas Law, Development, and Investment
(Apr 2013)
CHAPTER 3B
POLITICAL RISK MANAGEMENT IN LATIN AMERICAN NATURAL RESOURCES PROJECTS: THE TOOLBOX¹
Elisabeth Eljuri ^*
Global Practice Leader Latin America, Norton Rose
Caracas

ELISABETH ELJURI is Global Practice Leader of the Latin American Practice of the global firm Norton Rose. She is also one of the firm's senior natural resources practitioners and head of the corporate department in Caracas. Elisabeth received her law degree from Universidad Cató1ica Andres 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. Elisabeth is President-Elect 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. Likewise, Chambers ranked Elisabeth as one of the top 20 energy lawyers in Latin America and Star Individual for Venezuela and so does Legal 500. Legal Media Guide's listed Elisabeth among the top 25 Natural Resources and Energy Lawyers in the world.

Contents

I. Introduction

II. An Overview of Political Risk

III. Political Risk in the Energy and Mining Sectors

A. Resource Nationalism

IV. Types of Political Risk

A. Expropriation

1. Direct Expropriation

2. Indirect Expropriation

B. Contract Risk

1. Contract Breach and Repudiation

2. Forced Renegotiation

C. Restrictions on Arbitration

V. Mitigating Political Risk

A. Contractual Remedies

1. Stabilisation Clauses

2. Adaptation Clauses

3. Further Contractual Provisions

B. Political Risk Insurance

1. Public Political Risk Insurance Providers

2. Private Political Risk Insurance Providers

3. Application of Political Risk Insurance

C. Bilateral Investment Treaties

1. Investment Structuring

2. Treaty Planning (Potential for Treaty Shopping)

3. Denial of Benefits Clauses

4. Remarks on Qualifying Investments

VI. Conclusion

VII. Bibliography

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Abstract

Regardless of the nature of the host government contract that grants mining or petroleum rights, there are numerous measures that investors can take to minimise contract and country risk. Most of these measures are preventive measures that need to be addressed in advance, but others are responses to specific threats that an informed investor needs to be mindful of. In the area of natural resources, the battle of resource sovereignty versus contract sanctity is ever present and policy decisions may change investment environments fairly rapidly. Successful investors are those that are able to anticipate potential risk and plan accordingly, bearing in mind that some risk is always inevitable.

I. Introduction

When an international oil company (IOC) decides to invest in a foreign country, it must assess the commercial feasibility and the expected return from a project while considering both the investment environment and political regime.¹ All investments come with some degree of risk, and there is usually a positive correlation between this and an investment's potential return.²

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Aside from the more usual investment or market risks, investors in international energy projects must take into account those that are unique to specific investments and those that are particular to the sector as a whole.³ Energy projects commonly lack certainty due to the economic, financial and political risks that are encountered.⁴ These investments are usually based on a separate negotiated corporate-host investment agreement that enables investors to address their needs, which are often particular to each project.⁵ The real concern of investors when using such contracts is not so much the possibility of host governments leveraging their strong bargaining positions to lead to unfavourable terms, as the possibility of being subject to political risks -- that is to say, political processes and current events -- which may hinder the achievement of their goals and operations. Unfavourable terms may be rather unpalatable, but are at least able to be factored into investment decisions and dealt with in advance.

II. An Overview of Political Risk

Political risk may be defined as "the risk or probability of occurrence of some political event(s) that will change the prospects for the profitability of a given investment."⁶ Shell defines political risk more broadly as "the probability of not maintaining the described contract [for its term] in the face of changing economic and political circumstances."⁷ These definitions outline the consequences of encountering political risks, but fail to explain the sources and motives behind such occurring. Restrepo et al. define political risk as "the risk associated with the effect that actions of agents pursuing political objectives may have on the value of ... assets ..."⁸ Such a definition is more instructive, in terms of pointing to an analysis of those creating the risk, such as governments, political activists and military or terrorist groups.⁹

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What the above definitions have in common is the matter of probability,¹⁰ relevantly, the probability of some kind of interference in projects in a sector where changes are of no surprise. While a wide range of actors may bring about political risk, many authors agree that whether on a national, regional, or local level, it is host governments that are the main drivers of such.¹¹ Examples may be found in Latin America: whether seizure of foreign-operated facilities in Argentina, Bolivia and Venezuela, a revised and renewed tax assessment scheme in Peru or adoption of a new hydrocarbon regime with varied royalties in Bolivia,¹² it is host governments in most all cases that have created such risks. This does not, however, negate the possibility that other non-government actors from within the industry can create political risk and harm investors.¹³

III. Political Risk in the Energy and Mining Sectors

There are a number of reasons why energy investors are more vulnerable to political risk than investors in other sectors.

First, energy projects are unique in comparison to many other types of projects; they involve transactions between investors and host states,¹⁴ involve technically challenging activities and are both capital intensive and of lengthy duration.¹⁵

Secondly, energy investments are long-term fixed investments and are 'quasi-irreversible'. Moran notes that investors cannot, in the short-term, 'pack up and leave', or, when in negotiations with host officials, convincingly threaten to do so -- at least not without incurring great cost.¹⁶ As a result, host governments, aware of their strong bargaining positions, may behave in an opportunistic way to the detriment of the investor.¹⁷ Such behaviour is further motivated by elevated global energy prices, a continuously sensitive state of geopolitical relations and the presence of national energy companies (NOCs), which encourage host governments to seek flexible agreements, larger profits and greater sovereignty over their natural resources.¹⁸

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Thirdly, investment agreements in the energy sector usually involve long-term concessions or licenses that include flat royalty and tax rates; these agreements are not usually designed to accommodate significant operational changes, such as elevated commodity prices or evolving economic, political or social conditions. As such, governments often challenge these agreements as exploitative, unfair or not sufficiently beneficial to the host country (sometimes forgetting the high risks the investors took in the early stages of a project).

A. Resource Nationalism

The underlying vulnerabilities of energy projects lie in the fact that the natural resources sector is economically and politically charged, at least on account of the sheer magnitude of economic wealth yielded by reserves and the strategic influence that derives from relatively inelastic global demand. This is compounded by the fact that the natural resources sector often represents the primary source of income for resource-rich states. The importance and impact of this often extends directly to the citizenry of such states and not merely their governments: Erkan notes that public wellbeing often relies upon high revenues derived from royalties from energy contracts to lead to higher mean salaries, better education and general wellbeing.¹⁹ Inevitably, such awareness exerts a strong influence on the political process, whereby politicians may take measures or otherwise behave on account of populist domestic considerations or ideological grounds, usually with negative implications for foreign investors.²⁰ This is based on the fact that "an action regarded by one investor as discriminatory 'intervention' may be perceived by other observers as an appropriately imposed differential treatment by an intelligent 'government'."²¹

In recent years, a...