The Function of Stabilisation and Renegotiation Clauses in Production Sharing

Explain the function of stabilisation and renegotiation clauses in production sharing

Introduction

“The production sharing agreement is a contractual agreement made between a foreign oil company (contractor) and a designated state enterprise (state party), authorizing the contractor to conduct petroleum exploration and exploitation within a certain area (contract area) in accordance with the rules of the agreement. The authority of the state party is either based on the possession of a specific exclusive license granted under the rules of prevailing legislation, in which case the area of the agreement coincides with the area of the license, or on a general exclusive authorization ( and duty) to undertake petroleum operations for the whole country without specific obligations attached thereto.” [1] The precise and specific terms and the conditions governing the agreement differ in each case and depend entirely on the negotiation between the state and oil company. The agreements often contain a “stabilization clause” which restricts the future governments’ authority to change existing tax laws or introduce new laws which affects the profitability of the investor. [2]

The stabilization clause:

The stabilization clauses which are included in the current international petroleum, gas and mineral agreements have become a common feature. They protect the interests of both the contracting parties to the agreement concerned against any unilateral termination or modification by either party without mutual consent of the other party obtained in advance [3] . They safeguard the interest of the foreign investor intending to invest in a country which has different socio-economic conditions prevailing and different legal systems in practice. Out of many concerns, which the investor has in his mind, political instability and poor governance of the host state tops the list. [4] To avoid worst fears come true, investors generally demand legal guarantees from the government of the host country in which they intend to invest huge amount of capital and technical know-how. The banks and financial institutions which finance the project fear the same risk as much as an investor does and would like to see the stability in the contractual regime. Therefore a contractual obligation in the form of stabilization clause is believed to be the panacea for all such feared risks. Thus the inclusion of the stabilization clauses creates a standard pattern and thereby avoiding the whims and fancies of the government which otherwise jeopardizes the interest of the investor. As one scholar observes:

“At the dawn of the 21st Century, stabilization clauses are more than ever becoming an essential legal tool in the management of political risks which far from having disappeared; seem rather to sometimes extend to areas formerly viewed as stable.” [5]

Functions of the stabilization clauses

“Since the philosophy behind the inclusion of stabilization clauses in the agreements is to render the agreements and preclude it from any subsequent adverse act of the government whether legislative or administrative, typical provisions in such a clause specifically preclude the application to the agreement of any subsequent legislative (statutory) or administrative (regulatory) act issued by the government or the administration that may adversely impact the contractual regime already entered into by the parties.” [6] “The main purpose of the clauses is to tie the hands of the state party during the life of a project under an international energy and natural resource development contract so that the state party cannot interfere with the interests of the investor” [7] . The driving force behind the negotiation of such clause to be included came as a result of continuous and growing fear of expropriation of the host government. The concern along with the interest of the governments to attract more and more investors forces them to submit to such prospective investors demand. [8] Stabilization clauses assure the investor of any future actions of the government or any laws made by the host government which may affect the terms of the contracting agreement. “Stabilization clauses “specifically seek to secure the agreement against future government action or changes in law,” either legislative or regulatory. More specifically, a stabilization clause is a specific commitment by the foreign country not to alter the terms of the agreement, by legislation or any other means, without the consent of the other contracting party.” [9] Stabilisation clause is divided into number of categories.” A clause that provides the government may not unilaterally modify or terminate the contract has been called an “intangibility clause.” “Another variety, usually called a “stabilization clause stricto sensu,” states that the governing law of the contract shall be that of the contracting state at the time the contract was executed, thereby preventing the application of subsequent changes in the contracting state’s law”. “Another type of stabilization clause provides that the agreement shall be performed consistently with “good will” or in “good faith,” thus precluding unilateral modification or termination” [10]

Do Stabilisation clauses achieve their Goals:

It is beyond reasonable doubt that the oil and gas contracts are influenced by many dynamic factors such as market conditions and the political stability of the country and the state of the economic governance in a particular country. Even a country which is highly noted for its stability in governance and control over policies as Norway has changed the tax-rate, two-fold of the agreed rate, soon after the discovery was made at the North Sea. [11] Regardless of the stabilization clause, the approach works true in many situations like this. In reality the stabilization clauses cannot stand the pressure of the dynamic market conditions and the high volatility of the oil prices. For example Bolivia has nationalized the oil fields regardless of the commitment to continue low tax regimes introduced in 1990’s. [12] It is often a considerable note that the fiscal policies of the countries keep changing from time to time irrespective of the commitments they are obliged with. During the price rice during 80’s and early 90’s, countries like China and Algeria have resorted to windfall taxes against the promises they have made in the stabilisation clauses. Some countries have even gone further to engage themselves in what could amount to a ‘creeping expropriation’ [13] . A key concern for investor is the enforceability of such clauses if the host state turns hostile in respect of certain issues which have already been concluded between the parties. There have been many issues both in domestic law and also in international law. “In fact, examining it in the light of fundamental principle of permanent sovereignty over natural resources, some authorities even deny the legal force of any clause that restricts the state’s legislative sovereignty by a contract with foreign oil company”. [14] Even in domestic laws it is noted that a contract cannot be enforced which prevents the application of subsequently enacted laws. It is established principle in many jurisdictions that the executive powers of the state cannot be fettered by the contract with a private individual or corporations. The position is same in England and Wales and in some Middle Eastern countries. [15] The position is same with international law as the law prescribes the agreements to be compatible to the norms of international laws. It is held that a state’s authority over its natural resources cannot be contracted out for. [16]

The Re-Negotiation Clause:

“Renegotiation clauses are provisions in contracts that, upon the happening of certain event or events, require all parties to return to the bargaining table and renegotiate the terms of their agreements. Professor Berger states that these clauses are particularly useful in international investment contracts between a private party and a government entity. He argues that because these contracts are of typically long duration, the political, economic and social climate could change radically during this period and dramatically alter the economic benefits that the parties originally envisioned would flow from the agreement.” [17] The use of renegotiation clause has gained tremendous importance especially in the petroleum development agreements as it has become a suitable alternative to the classical stabilisation clauses in this respect. The negotiation clause allows the parties to accommodate the fundamental changes to the already existing agreement. [18]

Functions of the Renegotiation clauses

The renegotiation clauses strike a balance between the investor and the host government. The clause tries to preserve the interests of both the parties by leaving the state’s sovereignty intact and at the same time protects the investor against changes in law governing the agreement. [19] The renegotiation clause in an agreement allows modifying the agreement which is previously concluded between the parties rather than the termination of contract by either party when a dispute arises. Such flexibility to modify the terms reduces the risk of termination of the entire contract which results because of a dispute between the parties which arises during the course of business. Therefore it can be termed as a means of stabilising the relationship between the parties. [20] The purpose of the negotiation clauses is often achieved if the scope is limited to unforeseen conditions not within the control of either of the parties. The UNIDROIT principles also lays down a framework in which renegotiation can occur. [21] “Where there is no renegotiation clause in the agreements, it may be difficult to bring the less vulnerable party back to the negotiation table. This offers as a dispute resolute mechanism between the parties and an occasion to resolve the unfilled gaps in the contractual agreement.

Do Renegotiation clauses serve the Purpose:

“Renegotiation clauses are not a panacea; they have a number of draw backs. Investors may refuse to indicate them in their contracts for five reasons. First, such clauses may reduce contract stability. Second, including renegotiation clauses may raise the overall costs of the transaction. Third, if the parties are unable to agree as a result of renegotiation and third party adaptation of the contract is sought an arbitral tribunal may decline to exercise its jurisdiction or the adaptation may be unenforceable because of lack of a dispute between the parties. Fourth, if the parties’ original agreement fails to provide the tribunal with sufficient parameters to adapt the contract, the tribunal may re write the agreement in a way that neither party intended. Fifth, if the events which trigger the renegotiation may be within the control of the host state, raising the possibility that the process could be used unfairly to alter the agreement.” [22]

Conclusion

Most often the petroleum development agreements are influenced by the dynamic factors like price rice, political, economic and social conditions. In such cases investors need to be assured that the agreement has stability and cannot be changed according to the whims and fancies of the host government. The stabilisations clauses become unenforceable sometimes as they are often imposed by the constraints of legal and constitutional framework of the host country. [23] The oil company will therefore be left with no protection against the hostility of the state. Therefore in practicality the stabilisation clauses as the name suggests are not able to render their protection to the investor.

According to me, the negotiation clauses which are designed to protect the relationship between the investor and the host state is preferred rather than unilateral termination by the stronger party and the leaving the other party helpless and put to losses. The negotiation clauses try to bridge the gaps in the concluded agreements according to the changing political economic and technological conditions.therfore it is encourgaged to include the negotiation clauses in the production sharing agreements in the light of the above conditions.

WORD COUNT: 2167 (INCLUDES THE FOOT NOTES BUT EXCLUDES THE BIBILOGRAPHY)