Stabilization Clauses In International Oil And Gas Contracts: An Overview

Types of Stabilization Clauses

Demonstrate a good understanding of the substantive rules of international law applicable to the oil and gas industry.

Evaluate the key principles of contract formation in international commercial transactions and key international law principles and trends in the oil and gas sector.

ssess the effectiveness of international law in addressing the environmental impact of oil exploration and exploitation.

Demonstrate a critical understanding of the importance of oil and gas law as a distinct subject, studied in a practical and commercial context.

Stabilization clauses have become an important part of the international law. These clauses can be found in long-term investments or in concession contracts entered into between States and international investors (Singh 2015). A stabilization clause seeks to give protection to the contractual parties by preventing arbitrary future measures of the parties. The laws and regulations applicable to contractual parties may change over the life of a contract. Some changes may adversely affect the economics of a project. The investors, therefore, incorporate stabilization clauses to mitigate such risk. Stabilization clauses thus aim to keep the project insulated from adverse changes to fiscal and legal environment (Dalhuisen and Guzman 2013). Over the years, the international tribunals have recognized stabilization clauses in contracts and they have upheld the validity and effect of stabilization clauses. Thus, the main purpose of incorporating a stabilization contract is to secure the position of the parties with respect to the agreement into which they enter. Stabilization clauses have mostly been incorporated in oil and gas contracts. International investors are prone to invest a lot of money in oil and gas sector as they foresee a huge profit out of the contracts entered into by them with the host countries. A small change in the law of the host State may cause huge loss to the investors. Stabilization clauses play a vital role in protecting the interests of such investors (Kuznetsov 2015). This essay is concerned with the issues relating to the stabilization clauses and highlights the nature of such clauses in the light of relevant case laws.

There are different forms of stabilization clauses, which are incorporated in agreements. Most notable forms of stabilization clauses are freezing clause and economic equilibrium clause. A freezing clause requires the fixation of law, which is applicable to the parties at the time when the contract was entered into between the parties. It means that the State agrees that any change which is brought to the legislation after the date of making of the contract will not apply to the contract. Further, if a new legislation is brought and it is inconsistent with the provisions of the contract, then the portion of such new legislation as far as it is not consistent with the contract, will not be applicable to the parties with respect to such contract. An economic equilibrium clause does not intend to stabilize the legal or fiscal framework but it is designed to stabilize the investor’s economic return. Thus, a new legislation, if enacted by the host State after the date of making of the contract, would apply to the contract but the host State has to pay compensation to the investor for complying with the new law (Mansour and Nakhle 2016). Economic equilibrium clause thus keeps the economic equilibrium of the contract maintained. The compensation may be paid in the form of reduction in tax payments, monetary compensation or extension of concession. Under the economic equilibrium clause, the parties act in good faith and ensure that the economic equilibrium is restored in the initial form, as it was, before the new law came into effect (Ray 2013).

Relevant Case Law

The issues relating to stabilization clauses have been addressed in a number of cases over the years.  In the case of Texaco Overseas Petroleum Company vs. Libya (1977), Deeds of Concession were entered into between Texaco Overseas Petroleum Company (TOPCO) and the Government of Libya. The parties in the Concession incorporated a stabilization clause. According to the stabilization clause, the Government of Libya was required to take all steps which were necessary to ensure that the rights conferred to TOPCO were not adversely affected. For bringing any changes to the right of the Company, the mutual consent of both the parties to the Concession was necessary. The stabilization clause also laid down that the Petroleum Rules and Regulations, which were in force at the time of agreement, would be applicable to the parties throughout the life of the agreement (Ho 2014).

The effect and validity of the stabilization clause was questioned before the arbitrator (Childress 2013). The arbitrator held that the government of Kuwait has full sovereignty and legislative competence to enact any law relating to the petroleum. It can make rules and regulations and can regulate those companies with which it had not entered into any prior commitment. In the present case, the Government of Kuwait has entered into a commitment with TOPCO through a stabilization clause and it is therefore bound by the terms of such clause. The Government can enact any legislation but the stabilization clause would not be affected by any such new legislations. The stabilization clause was thus validated and given full effect in this case (Hamamoto 2015).

In the case of AMINOIL vs. Kuwait (1982), the act of nationalization of an American Company, AMINOIL by the Government of Kuwait was challenged. In this case, the State of Kuwait had granted a concession to an American company, American Independent Oil Company for exploiting and exploring natural gas and petroleum in the Saudi Arabia-Kuwait Neutral Zone. A concession agreement was entered into between the parties in 1948. The terms of the agreement was modified subsequently by a Supplemental Agreement of 1961. In 1973, a draft agreement was further prepared by the parties which sought to amend the previous terms and conditions. In 1974, “Abu Dhabi Formula” was adopted by the Organization of the Petroleum Exporting Countries. Under the said Formula, taxes were raised on the oil produced by AMINOIL. Objection was raised by AMINOIL regarding the enforcement of this Formula. In 1977, the Government of Kuwait through a decree, terminated the concession agreement with AMIMOIL and nationalized the assets of AMINOIL (Ayad 2013).

Effectiveness of Stabilization Clauses

The said act of the Government of Kuwait was challenged by AMINOIL before the Tribunal. AMINOIL contended that the stabilization clause prevented the Government of Kuwait to nationalize then assets of AMINOIL. The Company referred to the actual language of the stabilization clause, which stated that none of the parties could make any addition or deletion or alteration to the concession agreement unilaterally. Thus, according to the Company, the act of nationalization of the Government of Kuwait was not allowed in the light of the stabilization clause (Badah 2015).

The Tribunal held that the act of nationalization of the Kuwaiti Government was not unlawful in the light of the stabilization clause. The case of nationalization was not clearly mentioned in the stabilization clause. Therefore, the Tribunal was of the opinion that the stabilization clause did not expressly prohibit an act of nationalization and consequently the Tribunal upheld the decree passed by the Kuwaiti Government in 1977 (Foucard and Grandfond 2015).

The issue of nationalization of an oil distribution Company was again raised in the case of AGIP vs. Congo (1979). In this case, AGIP and Congo became half owners of a Congolese oil distribution Company, pursuant to an agreement entered into between them in 1974. A stabilization clause was incorporated in the agreement, which stated that no decrees or ordinances would be passed by the Republic of Congo which would change the joint stock nature of the company or would alter the Articles of Association of the Company.

In 1975, the said company was nationalized by the Republic of Congo and AGIP was not compensated for its shareholding. The act of nationalization was challenged on the ground that it breached the stabilization clause (Gehne and Brillo 2014). 

It was held that the act of nationalization was not in conformity with the stabilization clause, which clearly demonstrates the unlawful character of the act of nationalization. The Republic of Congo was required to compensate AGIP for the damage which was caused to AGIP by the act of nationalization. The decision clearly validated the effect of stabilization clause on parties entering into such contracts (Mato 2012).

The validity of a stabilization clause was once again questioned in the case of Letco vs. Liberia (1986). In this case, the State of Liberia had entered into a Concession Agreement with Letco. Under the terms of the contract, the Liberian law was applicable to the parties. Under the stabilization clause, to bring a change in the Concessionaire’s right, a mutual decision of the parties was necessary. Thus, as per the terms laid down in the stabilization clause, the Government of Kuwait was not allowed to bring any changes in the law, which would affect the rights of the Concessionaire. The Tribunal was of the opinion that a legislative measure which seeks to terminate the concession agreement or which seeks to bring changes in the righs of the Concessionaire would definitely be invalid in the light of the stabilization clause. But an act of nationalization by the Government of Liberia would not be set aside on the ground that it is not in conformity with the stabilization clause. Thus, the Tribunal in this case has taken a similar view which was taken in the case of AMINOIL vs. Kuwait (Saleem 2013).

Conclusion

The Iran-US Claims Tribunal discussed several points in the case of Amoco vs. Iran (1987). The primary questions, which were dealt with by the Tribunal, were firstly, whether clauses incorporated in the parties’ agreement were indeed stabilization clauses or not; and secondly, Whether the Government was bound by such clauses or not.

In this case, an agreement known as Khemco agreement was entered into between the National Petrochemical Company (being under the direct control of the Government of Iran) and Amoco, which was the investor. The claimant argued that Article 30 and Article 21 of the Khemco agreement were stabilization clauses. Article 30 of the agreement specifically provided that any law, prevalent in Iran, at the time of the agreement, to the extent it is inconsistent with the  provisions of the Khemco agreement would be considered to have no effect on the parties. The Tribunal laid emphasis on the point that the essence of a stabilization clause is to regulate the future measures of the parties. Article 30 did not mention about any future measures and therefore it did not satisfy the criteria in order to be considered as a stabilization clause (Schefer 2013).

Article 21 laid down that the provisions of the agreement could only be amended, annulled, or modified only with the mutual consent of both the parties. A unilateral measure taken by a single party would not be able to bring any changes in the said provisions. The Tribunal interpreted the term ‘measure’ and was of the opinion that in the context of a stabilization clause, the term ‘measure’ only means legislative or regulatory measure. However, none of the parties to the agreement actually had the power to take any legislative or regulatory measure. Therefore, such clause could not be considered a stabilization clause.

Addressing the second question, the Tribunal opined that the agreement has been entered into between Amoco and National Petrochemical Companies. Since the government of Iran was not a party to the agreement, therefore the clauses would not be binding on the Government.

Further, the Tribunal in this case held a similar view to that of the Aminol case that a stabilization clause cannot invalidate an act of nationalization unless it is expressly mentioned in the clause (Escarcena 2013).

Thus, in the light of the above cases, stabilization clauses have been given importance and have been considered as valid and effective clauses in regulating the acts of the host States and the international investors. However, the Tribunals have taken a lenient view in issues relating to stabilization clauses in the cases of nationalization of oil and gas companies by the host States. In such cases, the tribunals have been reluctant to enforce the stabilization clauses in absence of clear prohibitory language in the stabilization clauses.

Stabilization clauses seek to protect the international investors against adverse changes in legislations or regulations under which their long term contracts with States operate. Economic equilibrium clauses have been favoured by the investors as these clauses have a higher possibility of being enforced than other forms of stabilization clauses. A clearer compensation mechanism is given under the economic equilibrium clauses. However, compensation is not easy to calculate and investors have limited recourse to the domestic courts of the Host States. Therefore, the investors are advised to look into the governing law of the relevant contract, the socio economic environment in which the contract operates and the compensation mechanism in negotiating stabilization clauses with the host State.

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