NATURE-AND-EFFECT-OF-STABILISATION-CLAUSES-IN-OIL-AND-GAS-CONTRACTS

NATURE AND EFFECT OF STABILISATION CLAUSES IN OIL AND GAS CONTRACTS

1.0. Definition and History

Stabilization clauses may be defined as those provisions in an investment contract which aim to preserve the legal and economic bargain as agreed by the investor and the host state at the outset of the investment.(Mario Mansour & Dr Carole Nakhle-2016)  They are believed to have emerged between the world wars when United States companies sought to preserve the terms which they had agreed over the length of their contracts in the wake of a spate of nationalization in Latin America.

2.0. Nature and Rationale

The appetite of oil and gas investors depends not only on the amounts of money they return on investment, but also the extent to which host governments are willing to share the project’s risks and protect such companies from any form of either direct or indirect expropriation. Hence many International Oil Companies(IOCs)seek stabilization mechanisms mainly because of the potential financial benefits they provide in protecting them against the dynamic and ever changing legal regimes in a given state, for instance a Fiscal Stability Clause(FSC) may shield the company against the  government’s desire to  increase tax once exploration yields  positive results. Apart from the FSCs -which deal exclusively with specific taxes and royalties, or all taxes and fees, potentially including duties on imported material and capital equipment, Stability clauses may also cover laws relating to: labour, the environment, government control over production decisions and share participation, the obligation to provide local infrastructure, and the possibility of nationalization, among others.(Mario Mansour* & Dr Carole Nakhle-2016)

3.0. Categories of Stabilization clauses

Stabilization clauses can broadly be divided into two categories:clauses which impose an obligation on the host state not to apply any changes to the laws in place from the time the contract is entered into (freezing clauses) and clauses which provide for adjustment of contractual terms to reflect such changes. The purpose of the latter clauses is not to prohibit actions by the host state. Rather, it is to prescribe the consequences of such actions. In recent times,“freezing clauses” which seek to prevent host states from acting as they deem fit have been dealt away with in favour of the more flexible adjustment clauses(also known as economic equilibrium clauses)(Shemberg, Andrea-2009). These may take the form of clauses providing that the contract adjusts automatically in accordance with an agreed formula upon the occurrence of a specified event (such as the increase in, or imposition of, a new tax).(Mario Mansour* & Dr Carole Nakhle-2016)

4.0. The Ugandan context

Alternatively, an adjustment clause may mandate negotiations between the host state and the investor to achieve an amicable settlement which ensures that the investor’s anticipated returns are maintained. This is the case for Uganda. Article 30.2 of the Model Production Sharing Agreement (PSA) provides as follows;

30.2 The Parties agree that the terms and conditions of this Agreement are based on the existing laws of the Republic of Uganda and the terms contained in this Agreement. If, following the Effective Date, there is a change in the laws of Uganda which substantially and adversely alters the economic benefits accruing to the Licensee, the Licensee may within thirty six (36) Calendar Months from the date on which any such change has legal effect, notify Government accordingly and thereafter the Parties shall negotiate to agree upon the effect of the changes in law and the necessary adjustments to the Agreement in order to maintain the economic benefit of the Licensee which existed at the Effective Date of this Agreement PROVIDED that the Licensee shall comply with the requirement of the law at all times.

30.4 For the avoidance of doubt, the provisions of paragraph 30.2 above are intended for maintaining the original economic benefits under the Agreement as at the Effective Date and shall not prevent the Government from enacting laws intended to levy additional profit tax on additional profits.

5.0. Effect on state sovereignty

The exercise of sovereign authority by the host state cannot be completely restrained by virtue of a stabilization clause. These adjustment clauses have been developed in ways that respect this reality, while at the same time protecting the economic equilibrium of the contract (Maniruzzaman, Munir A.F.M. (2008). Just as indicated in the clause 30.4 cited above, the government in anticipation of growth in profits for instance as a result of increase in oil prices, and due to the need to maximise benefits for the country at all times, may retain the power to alter the fiscal regime to potentially benefit from such changes without prejudicing the original economic benefits for the OIC.

Still in exercise of its sovereignty, the government may determine certain laws to which stabilization clauses may not apply especially those whose alterations or imposition, with time, may not have any significant effect on the prospected economic benefits of the company. For instance,  Paragragh 5 of Article 30 of Uganda’s model PSA adds that “The provisions of paragraph 30.2 above shall not apply to changes in the laws of Uganda regarding health, safety and environmental standards.” This implies that the IOC shall have to, at all times, adjust to any changes that may occur in such laws or to any of such laws that may from time to time be imposed.  It is also pertinent to note that any stabilization clause that contravenes the provisions of the constitution is null and void.(Article 2 of the 1995 Constitution of the Republic of Uganda).

6.0. Protection against Expropriation/Nationalisation

In light of states exercising sovereign authority, one may be left wondering to what extent a stabilization clause may go towards protecting an Oil Company against Expropriation or Nationalization of its assets. In light of Article 30.3 and Article 24 of Uganda’s model PSA, where the negotiations prescribed in Article 30.2 fail to yield any amicable settlement, the dispute may be referred for Arbitration in accordance with the United Nations Commission for International Trade Law (UNCITRAL) Arbitration Rules. A close look at some of the Arbitrar decisions over time reveals the fact that the modern consequence of the classic stabilization clause aimed at prohibiting an expropriation is not to invalidate a nationalization, but to make it unlawful, which in turn affects the amount of compensation that may be awarded.

For instance, The Tribunal in TOPCO v. Libya I.L.M.1;(1978) noted that ‘the Government could not exercise its sovereignty to nationalize in violation of its specific contractual commitments in the stabilization clauses, and the nationalization in the face of these stabilization clauses amounted to a breach of the Deeds of Concession.’

In AGIP v. Congo ICSID Case No.ARB/77/1, the Congolese government agreed in the Protocol Agreement to guarantee the stability of AGIP’s local subsidiary’s legal status. In Articles 4 and 11 of the Agreement, the government made a commitment not to apply any laws or decrees that would alter the Company’s legal status. The International Center for Settlement of Investment Disputes(ICSID) tribunal found that the nationalization of AGIP’s Congolese subsidiary was clearly inconsistent with the stabilization clauses, was irregular under international law, and gave rise to an obligation by the Government to compensate AGIP fully.

Conclusion

Therefore a breach of a stabilisation clause gives rise under international law to liability for compensation, and this is so whether the breach leads to formal or de facto expropriation or not and in case of a nationalisation, whether the property is tangible, such as real estate or a factory, or intangible, such as the contract rights. The issue is in regards to the amount of compensation payable. In that context, the lawfulness or unlawfulness of a nationalization may affect the standard for compensating as well as the amount of compensation payable.

REFERENCES

  1. The 1995 Constitution of the Republic of Uganda
  2. Uganda’s Model Production Sharing Agreement (PSA).2016
  3. Maniruzzaman, Munir A.F.M. (2008) ‘The pursuit of stability in international energy investment contracts: A critical appraisal of the emerging trends’, Journal of World Energy Law & Business, Vol. 1,No. 2 pp.121–57
  4. Shemberg, Andrea (2009) ‘Stabilization Clauses and Human Rights’, International Finance Corporation,World Bank Group.
  5. Mario Mansour* & Dr Carole Nakhle(2016) ‘Fiscal Stabilization in Oil and Gas Contracts: Evidence and Implications’Oxford Institute for Energy Studies Paper SP 37.
  6. TOPCO v. Libya I.L.M.1;(1978) 
  7. AGIP v. Congo ICSID Case No.ARB/77/1,