Dispute Resolution Mechanisms in the Petroleum Sector

3. Sources of Disputes

3.1        Sources of disputes – impossibility

Force majeure or the occurrence of unforeseen events can be a source of disputes since it means that one of the parties may be unable to fulfil its contractual obligations on a temporary or permanent basis. According to the general principles of law, force majeure may be a reason to terminate a contract, and it may be invoked even if not stipulated in the contract. However, force majeure can only be used to terminate a contract when an unforeseen frustration, which is outside the control of the investor, has persisted for a period of time or made the performance permanently impossible. For instance, during the revolutionary events in Iran between 1978 and 1979, Iran halted oil exports temporarily and a new government was established shortly after this; oil exports were then resumed. In an international arbitration case, the tribunal rejected Iran’s claim that the contract had been terminated due to force majeure because the frustration – the halting of oil exports – only persisted for a short time.

3.2         Sources of disputes – termination

The petroleum contract may have a termination clause which can be triggered if certain specified events take place, such as breach of contract (discussed further below) or change of circumstances that existed at the time of the contract.

In a change of circumstances, the contract may provide for a mechanism for parties to make variations to the contract, catering for (and defining) the change of circumstances. These clauses range from generally worded variation clauses which provide that changes require the parties’ consent, to more complex and detailed variation clauses providing for renegotiation of performance milestones and pricing mechanisms. For instance, in gas contracts which are usually reliant on debt financing, and cover long durations of time (as much as 25 years), parties would seek to provide for a review of some fundamental terms of the contract, particularly price, to cater for unforeseeable changes in market conditions.

Generally, as changes to contractual terms are usually a matter of negotiation and agreement, where there is no consensus, a disputing party may choose to terminate the agreement rather than proceed with changes. 

When termination is sought under a termination clause, whether the trigger event has happened or not, this might result in a dispute before an arbitral tribunal or any other previously agreed/default dispute resolution mechanism. The outcome may not be a termination; if the change in circumstances has made the contractual obligation so onerous these can be reduced to an equitable limit.

3.3         Sources of disputes – boundary disputes

Offshore oil and gas projects may face a situation where the relevant licence/concession area in which an oil and gas company is entitled to explore and/or produce falls within or near an area subject to an international maritime border dispute.

The United Nations Convention on the Law of the Sea (UNCLOS) is an ‘umbrella’ treaty providing an all-embracing regulatory framework for the use of the oceans and their resources signed by 168 states to date. UNCLOS provides the sovereign right of each maritime State to explore and exploit the natural resources of the Exclusive Economic Zone (EEZ), the seabed extending 200 nautical miles from its continental shelf, if this territory does not overlap with that of another maritime state. There can be overlapping claims between adjacent or opposite States for the 12-nautical mile territorial seas, the 200-nautical mile EEZ, and continental shelves, which may extend beyond 200 nautical miles.

Unresolved boundaries can be a significant obstacle for the economic development of resource rich states, because exploration cannot be undertaken in overlapping areas and because existing projects may be affected by changes in boundaries. UNCLOS embodies a specific dispute settlement mechanism (see below) to settle maritime boundary disputes. States may choose to take a pragmatic approach in unresolved boundaries and have a Joint Development Zone (JDZ), where the resource is jointly developed by the disputing States, rather than drag out the boundary issue and not benefit from the resource. Otherwise, if the oil and gas fields are located in an overlapping area, states may agree on a cross-border ‘unitisation’ of the oil and gas deposits or sign a Joint Development Agreement (JDA). Examples of the former can be found in the North Sea and of the latter in Timor Leste and offshore West Africa.

3.4         Sources of disputes - breach of contract

These disputes may arise from a breach of the Joint Operating Agreement (JOA), unitisation agreements, farm-out agreements, feasibility study and bid agreements, sale and purchase agreements and confidentiality agreements. The disputes may also arise from a breach of contract between operators and service contractors, such as drilling and well-service agreements, seismic contracts, construction contracts, equipment and facilities contracts and transportation and processing contracts. There may be an important public interest in how these disputes evolve, even if it concerns private or non-local companies, since they can affect the development of the state’s oil and gas resources. Depending on the dispute resolution provided in the contract (or by the default procedures) and the complexity and magnitude of the dispute, the cost, venue and time frame of their settlement would be wide-ranging. Some of the examples of different methods of dispute settlements in the oil and gas industry are explained below.

Breach of a petroleum contract may trigger a dispute under the terms of applicable law to such contract, but it may also result in a breach of an investment treaty (such as a BIT). A breach of contract does not automatically constitute a breach of international law. When a host State fails to comply with its obligations under the contract (acting under its commercial capacity), the investor may only resort to the remedies provided under the contract. A right under the contract could be deemed expropriated when the host state acts in its sovereign capacity.

Often a claim for contractual breaches may be brought when the BIT contains an ‘umbrella clause’ which compels the host state to observe any obligation it has entered into with an investor of the home state (the other contracting party of the investment treaty). In this case, the dispute that arises due to a breach of contract could be resolved either through the dispute resolution mechanisms under the petroleum contract, or through investor-state arbitration under the BIT.

Remedies provided for in petroleum contracts include: recourse to domestic courts; and alternative dispute resolution mechanisms, such as mediation or arbitration before national or international arbitration centres. It is common for petroleum contracts to include international commercial arbitration dispute resolution mechanisms.

3.5         Sources of disputes – lack of authority

A lack of authority of the state agency who signed the contract can also be a risk for parties that contract with it. For instance, Baghdad (Iraq) argues that the autonomous Kurdish Regional Government (KRG) lacks constitutional authority over oil and gas development agreements. In 2014, when the KRG commenced oil-exports to Turkey, piped from the KRG region, Iraq filed for arbitration with the Paris-based International Chamber of Commerce (ICC) against Turkey and the Iraqi state-owned pipeline operator BOTAS, for their role in facilitating oil exports from Kurdistan without the consent of the Iraqi federal government. A dispute concerning the lack of authority may also arise when the party making the contract lacks the authority to do so.

3.6         Sources of disputes – expropriation

In the oil and gas sector, expropriation of a foreign investor’s investment by the host state is a common subject in disputes. This can be either direct expropriation, for instance where the government takes over a factory or indirect ‘creeping’ expropriation. Creeping expropriation takes place gradually and through a series of measures that interfere with the enjoyment of investment rights. Although in such cases no single act constitutes expropriation, their ‘cumulative effect results in deprivation’. De facto expropriations do not necessarily occur steadily but may also result from ‘a single regulatory action’.

A case-by-case examination would be required to identify whether the state act was a non-discriminatory regulation for public welfare objectives and if the deprivation formed a central element of the state’s regulatory measures, or if was the investor which had breached host government agreements or violated any environmental permit that might justify a cancellation of its license. In each case, all contributing factors would need to be assessed by arbitral tribunals in light of principles of fairness and justice.

3.6.1         Expropriation versus nationalisation

There is sometimes confusion between the terms ‘expropriation’ and ‘nationalisation’. According to the United Nations Conference of Trade and Development (UNCTAD) study on the taking of property, expropriation applies to a particular investment. However, nationalisation refers to ‘measures affecting an entire economic sector or specific industry’. Measures having the equivalent effect to expropriation or nationalisation are, on the other hand, described as ‘measures resulting in substantial loss of control or value of foreign investment’.

There have been many cases in the past of expropriation, such as the infamous Kuwait v Aminoil case, and other cases from Libya, Venezuela, Russia and Ecuador that have been brought by investors claiming expropriation of their petroleum assets by the host government.

The body of customary international law on expropriation acknowledges that expropriation of foreign investment by the state is not an illegal act per se. Expropriation may  be lawful if it complies with certain conditions, generally: that it is public purpose; non-discriminatory; carried out under due process of law and in return for prompt, adequate and effective compensation that amounts to fair market value calculated immediately before expropriation and available in a freely convertible currency. These standards have been codified under the International Energy Charter Treaty (ECT) whose contracting parties are mostly within the Eurasia region, and other states including Japan and Afghanistan. Most, if not all, international investment treaties lay down principles to protect foreign investors.

In practice, direct expropriations and nationalisations have become uncommon, and often cases are brought against states that refer to the so called ‘creeping expropriations’ and de facto expropriations which are measures having an equivalent effect to expropriation or nationalisation. It is not as easy to establish indirect expropriation as it is to establish direct expropriation. Since the early 1960s, there have been attempts to determine what constitutes an indirect taking of property. Although it is almost unanimously appreciated that expropriations may occur without physical taking (intangible property rights, such as rights arising out of contract may also be subject to expropriation), there is no consistency for the applicable legal standard. For instance, a breach of contract may deprive the investor of its right and benefits of an investment, but not all contract breaches mean there has been indirect expropriation.   

Expropriation can be the subject of a contractual claim or an investment treaty claim, or both. In a typical international petroleum contract, the parties are the investor and the host government, or a host government agency. In an investment treaty, such as a Bilateral Investment Treaty (BIT) between two states, or a Multilateral Investment Treaty (MIT) such as the ECT, the parties are the different states. The investor is not a party, but its rights are protected under the treaty as a national of one of the home contracting states. A petroleum contract between an investor and a state does not operate as a treaty between a host state and the investor’s state. 

The different claims can have different impacts for the investor. In a contractual claim, the expropriation may be a breach of a stabilisation clause. In a treaty-based claim, expropriation may be a breach of the treaty obligations against illegal expropriation, the fair and equitable treatment standard and principles of international law. It is now common to find investors instituting, in parallel, a contractual claim under the dispute resolution mechanism in the contract, and a treaty claim under the dispute resolution mechanism in the investment treaty to improve the chances to win. It should be noted that treaty-based claims depend on whether there is an investment treaty between the host state and the state in which the investor is a national.