Dispute Resolution Mechanisms in the Petroleum Sector

9. Industry View

The oil and gas industry is a fast moving, commercially significant and politically sensitive sector. Hence, it is important to swiftly identify and anticipate the dispute settlement mechanisms that may be most effective and appropriate in resolving the disputes which a particular project/investment may face.  The chosen procedure should be effective and rapid but also adaptable and one that would cause minimum damage to mutual interest and relationships, so that the project and work in progress is not damaged. For instance, ECT Article 7 on Transit requires the transit flows of oil and gas to continue despite an existing dispute unless otherwise allowed in the contract. With the aim of settling the dispute with the slightest of disruptions, industry may prefer negotiation and mediation before going to arbitration and litigation.  

9.1       Contract stability

Resource rich developing countries tend to be located within ‘high political risk’ geographies – and the risk of direct or creeping expropriation, and the pursuit of long-term investment stability has been a critical concern for the IOCs. In practice, alternative ways of ensuring contract stability have emerged over time. One such approach is to include a stabilisation clause within the petroleum contract, which would aim to provide ‘contractual assurance that the investment terms at its core on the date of signature will remain the same over the life of the agreement’. Essentially, the parties here would be seeking to protect both the economic terms and the implementation of the project, for example by limiting unilateral action by the host state, modification of the contract or the taking of investment property. In the petroleum industry, there are four common ways of incorporating a stabilisation clause. These are:

  1. Freezing: Restricts the state’s ability to make any alterations to national law applicable to the contract, by freezing these provisions as of the date of the contract. This would not mean that the host state cannot make a lawful expropriation: it can, but the effect of this clause would be felt when an unlawful expropriation is identified by the tribunal as it would increase the amount of compensation awarded.
  2. Intangibility or prohibition on unilateral changes: Unlike freezing, this clause prevents any unilateral changes to the petroleum contract. Any changes can only be permitted by the mutual consent of the host state and the International Oil Corporation (IOC) which encourages parties to negotiate, rather than restricting states ability to make changes to its legislation.
  3. Economic rebalancing: This is to protect the original economic bargain of the contract against a host state’s legislative or policy measures which may have an impact on the economic balance of the contract. The clause may propose a set of automatic and detailed measures for the rebalancing of economic bargain set in the beginning, or it may be open ended. A negotiation procedure might be imposed when the trigger event occurs.
  4. Allocation of burden: Shifts the fiscal burden of unilateral change by state action from the IOC to the National Oil Corporation (NOC), or in some cases to the state. This shift may be in the form of a payment (tax or royalty) on behalf of the IOC by the NOC as a remedy, or in kind such as its share of oil.

There is often thought to have been a considerable decline in the use of freezing clauses, although the confidentiality of most contracts makes this impossible to substantiate with certainty. The rise of state petroleum companies has meant that a favoured method of stability in oil and gas contracts is the ‘allocation of burden’. Balancing or renegotiation clauses are also quite common in drafting practice, although there are many different kinds. In practice, it is also possible to have a hybrid approach where more than one type of stabilisation is incorporated in a clause or a contract, requiring a careful reading of the whole document. In any event, the investment may be better protected if the clause imposes penalties for non-compliance and a time limit for negotiations, ideally followed by a second tier, arbitration option (if negotiations fail within a delimited time).