Stabilisation clauses in oil and gas contracts

“Concerned of any future policy reversal measure that may put at risk
the terms of investment agreements, investors in the oil sector often
seek guarantee, contractual or otherwise. The need to address such
fears thus saw the proliferation of Stabilisation clauses in oil and gas
contracts. These clauses are believed to maintain the stability of the
terms that were originally agreed upon. In particular, the fiscal regime
aspect of the agreement is at the heart of such clauses.”
Extracted from University of Dundee, Centre for Energy, Petroleum and Mineral Law
& Policy, 2009
Assignment Task
With respect to the quotation above, evaluate the function and aims of
Stabilisation clauses and comment on how they seek to achieve the
stability that parties’ desire

Introduction

Most of oil and gas contracts formed between investors and various nations are long-term agreements that last for longer period. It is with do doubt that a number of changes might occur especially in the developing nations that might have significant influence on the contracts formed (Mansour & Nakhle, 2016, p. 29).  Governments are likely to change their policies and laws governing the extraction and production of oil and gas that might have significant influence effects on the investors or even interfere completely with the agreement formed between the nation and the investors. Due to these possible changes, there is a need to offer the investor some form of protection from the possible changes that can be made by the government, and from unforeseen circumstances for them to engage in the long-term projects. Stabilization clauses are in most cases resorted to offer such kind of protection. According to Kuznetsov (2015, p. 22) a significant number of contracts formed between the governments and oil and gas investors include stabilization clauses. The main aim of these clauses is to ensure that the contracts formed are not altered. The government in question is not precluded from making new legislations but rather prevented from enforcing new rules against the investors. Nevertheless, McPherson (2015, p. 33) has indicated that in reality, contractual stability have failed to be delivered with most of the governments announcing legal changes to amend an existing fiscal regime or law. In reference to this, the current paper presents an evaluation of the functions of the stabilizing clauses as well as their effectiveness in achieving the stability desired by both the contractual parties.

Stabilization Clauses

The stabilization clauses apply to the laws that affect the economic conditions of the contract. The scope of the clauses includes fiscal regime, labor legislation, property, export-import provisions, free transferability and contractual framework. Based on the above scope, there are three main types of stabilization clauses that are enacted in most of the petroleum agreements. These include the freezing clause, economic clause and hybrid clause. According to Olawuyi (2015, p. 253) the freezing clause is a type of stabilization clause that is the most common and far-reaching. The main aim of the freezing clause is to ensure that the fiscal regime or any relevant law that is applicable to the oil production project will not change over time within the duration of the said project. This kind of clause therefore freezes the laws or fiscal regime of the host nation on the particular day that the contract agreement is made and does not allow any future legislative changes being made by the government to apply to the investors.

The economic stabilization clauses aim at maintaining the economic equilibrium of the contract formed between the investors and the government to the host nation. The economic equilibrium clauses do not freeze the laws of the host nation but gives a leeway for the government to make legislative changes (McPherson, 2015, p. 31). However, the new laws enacted have to apply to the contractual agreement and the government in place has a duty to compensate the investors for complying with the new laws. As the name suggests, the hybrid clause mainly entails the mixed characteristics of the freezing and economic equilibrium clause. The hybrid clause requires the state to reinstate the position of the contractual agreement to the same position as it was before the change of law if at all changes are made to the legislative laws. Agreements formed between investors and oil producing nations can be based on either or all of the stabilization clauses depending on the nature of the agreement developed between the parties involved.

Functions and aims of the stabilization clauses

The main philosophy for the inclusion of stabilization clauses in oil and gas agreements is to preclude the agreement from any adverse actions of the government whether administrative or legislative. The provisions in the stabilization clauses are mainly to prevent the possible statutory or regulatory acts of the government that might have adverse effects on the contractual regime that was already entered into by the contracting parties at earlier dates. The main function of the stabilization clauses is therefore to prevent the state party from interfering with the agreement set with the investors during the life of the investment being carried out (Frank, 2015, p. 91). The major reason for the inclusion of such clauses in the agreements was to attract more investors into the host nation. The continuous fear of expropriation by the oil producing nations that was developed by the investors prevented majority of them from engaging in oil exploration activities forcing the governments involved to submit to the prospective demands of the investors that required the inclusion of the stabilization clauses (Belal, 2015, p. 153). The stabilization clauses therefore have a major aim of protecting the investors from any adverse changes in regulation or future actions of the government that might interfere with the terms of the contractual agreement.

According to Mustafayev (2015, p. 32) the stabilization clauses have been included in the oil and gas agreements as a specific commitment by the host nation not to alter the terms of agreements developed between it and the investors. Honoring the terms of agreements entails the compliant with the requirements stated by the investors at the beginning of the project as well as ensuring that the investors only comply with the policies and rules that were stated at the initiation of the project. Apart from protecting the investors from complying with any other new laws formed along the way, the stabilization clauses also has a function of ensuring that the contract is made valid to the stated completion date. The “intangibility clause” provides that the host government cannot unilaterally terminate or modify the contact formed with the investors (McPherson, 2015, p.44). The decision to terminate the contract on oil and gas production does not solely rely on the host nation, but rather on the agreement between both parties (the host nation and the investor).

The stabilization clauses also have am aim of ensuring that the resulting agreement between the investor and the host nation is consistently performed with good will or good faith. The clause requires that the agreeing parties engage in the contract with good will such that any action of either of the parties is for the good of the other (Jamalinia, 2013, p.35). The stabilization clause therefore eliminates the possibility of enactment of laws or changes in laws by the government that is likely to have detrimental effects on the investors. Moreover, the stabilization clause aim at ensuring that the investor do not engage in activities that might have negative effects on the host nation through advocating for good will in all their actions. The stabilization clause therefore has a goal of eliminating any possible actions from both the parties that might have negative effects on both parties involved in the oil and gas agreement.

The role of the stabilization clauses in offering stability for the parties

Investors are likely to gain stability when they achieve maximum benefits from the investments carried out in the host nation. As such, the stabilization clauses have a role of ensuring that these investors gain the benefits they desire (Treves, Seatzu & Trevisanut, 2013). The stabilization clauses seek to achieve the benefits by ensuring that the host governments honor the terms of agreement set in the contracts. The investors are likely to accept terms that are beneficial to them, as such, when the host nations comply with the terms, they are likely to meet their investments goals. The stabilization clauses seek to ensure that no rules or policies are introduced, that are likely to have negative effects on the investment process, when the project has commended (Kuznetsov, 2015, p. 21). The clause focus on regulating the tax rate as well as preventing the enactment of fiscal policies that is likely to lead to the investors incurring additional costs in the investments. Through the above actions, the stabilization clauses are likely to ensure that the investors gain stability in their investment in oil and gas production.

The government and the investors all have a common goal of maximizing the exploitation of the hydrocarbon resources to produce the petroleum based products. However, the major aim of the investors is to ensure there is maximum return on the investment through the adoption of a simple or stable tax regime. On the other hand, the government seeks to acquire a fair share of the resources for the nation (Mansour & Nakhle, 2016, p. 31). Moreover, the government wants to ensure that the investment activities do not have any adverse negative effects on the environment as well as the community. The host nation also relies on the stabilization clauses to achieve some form of stability. The stability in this case relies on the ability of the nation to gain maximum resources for the nation and to offer maximum protection to the environment and the people from the possible adverse effects of the investment process (Kuznetsov, 2015, p. 22).

It has been argued that the stabilization clauses limit the ability of the host nation to effectively make legislation in line with human rights obligation. Some of the clauses that support the agreement on labor laws and environmental protection have in certain cases gone contrary to the human rights requirements (Mansour & Nakhle, 2016, p. 31). This has contributed to the carve-outs in the stabilization clauses that relates to environmental and employment laws such that the nations are not constricted to comply with the laws set at the initiation of the investment, but are at liberty to make adjustments as long as they are in compliant with the human rights obligation. These carve-outs ensures that as much as the interest of the investors are protected, the host nation is not limited in making legislation that  concerns human rights and the conservation of the environment, thus ensuring that the nation gain stability (Kuznetsov, 2015, p. 33).

Whether the aforementioned functions of the stabilization clauses have been accomplished is still debatable. Different scholars have presented deferent information on the practical nature of the clauses with authors such as McPherson (2015) indicating that the stabilization clauses are only applicable in theory and not reality. According to McPherson (2015, p. 28) the full protection of the investors even with the inclusion of the stabilization clauses has not been attained. The oil and gas contracts are largely influenced by a number of factors such as political stability and market conditions of the host nation. Weems (2013, p. 16) has noted that the stabilization clause formed cannot survive the high volatility nature of oil prices as well as the dynamic market conditions. Changes in tax rates are likely to be observed regardless of the commitment made by the oil producing nations not to increase the rates. The fiscal policies of most of the nations are also likely to change over time owing to the dynamic nature of the environment and the need by the host nation to observer human rights laws and offer maximum protection to the environment (McPherson, 2015, 34). The same changes in tax rate and fiscal policies have also been observed in nations that are highly noted to have stable control and governance such as Norway, meaning even with a stable governance system, there is likely to be changes in fiscal policies and laws governing the oil and gas agreements regardless of the commitments made by the host nations to honor the terms of agreement (Treves, Seatzu & Trevisanut, 2013, p. 45). The functions of the stabilization clauses stated above have therefore only been made in theory, however, their achievement in reality is yet to be reported.

Conclusion

The stabilization clauses if implemented can lead to both parties gaining the stability desired. However, the practicability of the honoring the obligations of the clauses is questionable and have proved impossible in most oil producing nations. The dynamic of what is considered a “fair share” of the resources for the host nation and the investor have proved to be fundamentally unstable owing to the dynamic nature of markets, the volatility nature of gas and oil prices, unprecedented geology, and intense competition within the global markets for the scarce resources and knowledge. As much as the goals of the stabilization clauses if well achieved will lead to both parties gaining stability, the instability nature of the environment under which the exploration of oil is done have interfered with the possibility of their full achievement thus rendering either of the party to gain some form of instability during the investment period.