Stabilization Clauses In Oil And Gas Contracts: Definition, Functions, And Types

What are Stabilization Clauses in Oil and Gas Contracts?

Discuss the stabilization clauses in oil and gas contracts.

International developments in relation to oil and gas industries are carried out globally according to which various oils and gas companies and the host countries of oil and gas reserve contract with different governmental authorities and private parties for sale and distribution of oil and gas (Oshionebo 2010). The global market of oil and gas is very fluctuating with introduction of new taxes and prices almost every month. All the countries in the world often announce various fiscal changes in relation to oil and gas industry which include changes in tax structures, amendments in current fiscal regime or introduction of new fiscal regime, closure of loopholes in taxations, etc. As oil and gas contracts are affected by these changes, it is very important to set defined principles which keep the terms of the oil and gas contracts that are active for years together, constant. The oil and gas contracts are valued at millions of dollars, which makes it very important to keep the fiscal aspect of the contract clear and with no doubt. And as the fiscal or the financial terms of these oil and gas contracts are affected the most with the various change that countries globally keep introducing, thus in order to keep the fiscal term of the oil and gas contracts constant and the same as decided at the time of making the said contracts, stabilization clauses are inserted in oil and gas contracts (Partlett 2010).

Stabilization clauses is a clause inserted in international agreements that state how changes in the law after the execution of a contract are to be managed and treated when the said changes affect or modify the rights and obligations of the contracting parties under the said international agreements (Hogan, Sturzenegger and Tai 2010). Therefore, stabilization clauses work as protection which is incorporated as a contract term in long investment or concession contracts between international investors in oil and gas sector or host countries with other governmental authorities. As the said contracts are active for long span of time, the applicable laws and rules often change from what was decided at the time of executing the contract. Sometimes, the said changes in law and rules modify or adversely affect the fiscal regime of these contracts. Therefore, in order to eliminate the probability of serious financial losses, the need of include stabilization clause in oil and gas contracts is essential. Thus, stabilization clauses are used largely in contracts of oil and gas sector, infrastructure sector and transport sector (Halabi 2011).

Why are Stabilization Clauses Important in Oil and Gas Contracts?

The primary intention behind inserting stabilization clause in oil and gas contracts is to neutralize the uncertain fiscal terms (Inkpen and Moffett 2011). The stabilization clause can be of different forms like the hybrid clause, freezing clause or the equilibrium clauses however, the primary aim behind contracting parties to insert the said clauses in contracts remain the same. This primary aim is lock the fiscal regime of the contract for the entire duration of the said contract. The term “stabilize” thus, in the said context refers to an effort to eliminate potential risk, conflicts and uncertainties which may arise as a result of alteration and changes in the laws and regime since the time the contract was executed. Thus, the objective of stabilization clause is to safeguard the interest of the contracting parties from modifications in the laws and governmental sanctions which are beyond the limits of the parties to control. Another important aim to insert stabilization clause in oil and gas contracts is to find appropriate investors for huge oil and gas projects (Erkan 2011). Most of the times, with all the uncertainties attached I oil and gas sector of fluctuating taxes and prices of oil and gas, investors are discouraged to put in their money, however, the remedy of stabilization clauses assures the investors against uncertain losses due to changes in laws, taxes, etc of any form. Thus, stabilization clauses in oil and gas contracts also help in acquiring investors for huge oil and gas projects all over the world. Stabilization clauses are designed to create a standard format which helps in avoiding any jeopardy concerning the terms of oil and gas contracts especially the fiscal terms of the said contracts. Therefore, in the recent times, stabilization clauses have become an effective and legal manner in which political risks are managed by contracting parties while making long term investment contracts (Mato 2012).

After reviewing the meaning and aim of stabilization clauses in oil and gas contracts, it is now important to note the varied functions of the stabilization clauses which are used in almost every oil and gas contracts. As the primary intention behind inserting stabilization clause in oil and gas contracts is to make the contracts unaffected by change in governmental provisions, the primary function of the stabilization clause is to insert within its scope a term that the said contract precludes any subsequent legislative or administrative acts or changes brought about by the governments of contracting parties and that the applicability of the said changes cannot be enforced by either of the contracting party on one another. The said function of the stabilization clause ensure the contracting parties of oil and gas contracts that any following changes in the legislative and administrative acts of the governments of the contracting parties will not adversely affect the fiscal regime of the oil and gas contract and the terms stand constant, which were decided when the contract was entered between the parties (Tienhaara 2012). Thus, the primary function of stabilization clause is to chain the hands of governmental authorities while the oil and gas contract is active in order that the changes initiated by the governmental authorities fail to interfere with the interest of the contracting parties in the said oil and gas contracts. The driving source of negotiating such stabilization clause in oil and gas contracts was started to eliminate the fear and risk of expropriation of the country which holds oil and gas reserves. Therefore, governments and investors of oil and gas sector are assured that subsequent amendments of statutory laws which are introduced by host countries will fail to affect the terms of the oil and gas contracts.

Functions of Stabilization Clauses in Oil and Gas Contracts

The stabilization clause works as a commitment by the host country to not alter or modify the terms of the oil and gas contracts as a result of any changes in statutory or legislative laws and rules. Thus, different types of stabilization clauses are used in oil and gas contracts however, the function of the all the stabilization clauses are the same (García-Castrillón 2013). A stabilization clause which fixes the terms of a contract to a particular domestic laws and regulations of one of the contracting parties which would make the terms of the contract unaffected by any potential change in the said domestic laws is called a freezing clause. A clause which grants exemption to investors in oil and gas contracts and does not automatically exempted the investors from change in current laws or formation of new laws affecting the terms of the contract is called a hybrid clause. A clause in which the investors are indemnified of the losses they suffer due to changes or modified laws and rules or taxations is called an economic equilibrium clause (Kuznetsov 2015). Thus, most of the stabilization clauses are meant to operate on good faith and good will which guarantee exemptions from any change in domestic laws and assure that the contract will be completed in full according to the terms mentioned in the oil and gas contract without applicability of any changed laws or taxations.

It is evident and established that oil and gas agreements are affected by many dynamic and drastic factors like market condition, taxation and political stability of the host country and the contracting country. In fact, it is evident that countries like Norway which are assumed to have high political stability have also altered its tax rates after the reserve of oil and gas were found in North Sea. Thus, stabilization clause is the only manner in which such uncertainties can be filtered and managed making stabilization clause a good legal approach to handle and manage risk associated with oil and gas contracts. However, the actual position of stabilization clause seems to be little different and sometimes it fail to adapt with the pressures of dynamic factors of political instability and change in laws. For example, Bolivia nationalized the oil reserves irrespective of the commitments it made with other governments to keep the taxes concerning the same low (Gehne and Brillo 2014). The fiscal regime and policies of every country keep changing irrespective of the commitments the government makes in form of treaties to keep taxations low. In the 80’s and some part of 90’s, countries like China had secured help of windfall taxes against the promises it made under the stabilization clause. Moreover, some countries went to the extent of squeezing certain projects in oil and gas sector with the help of taxes, change in laws and amendments in regulations irrespective of having a stabilization clause in the contracts of all those projects. Another issue the governments and investors who rely on stabilization clause have concerns its enforceability. Thus, enforceability of stabilization clauses in oil and gas contracts if the host country turns hostile with respect of particular issues which are already negotiated between the contracting parties. Another issue in the success of stabilization clause in reality is the difference in international law and the domestic law. Denying the international laws and fundamental policy of sovereignty on natural resources, some countries even deny the legal force along with the enforceability of any stabilization clause which prohibits or limits the country’s sovereignty over natural resources by any contract with other governments or private parties. Additionally, many constitutions of the different countries globally state that the executive authority and power vested in a state cannot be restricted by any form of contract with private parties or corporation organizations. Thus, the primary function of stabilization clause to tie down changes in domestic laws making it neutral for applying to modify or change the term of the oil and gas contracts is little difficult to meet its desired goals in reality (Sornarajah 2010). The protection of stabilization clause has many defenses in political principles of sovereignty and in the constitution of most of the countries. The situation is similar in the Middle Eastern countries and the United Kingdom, thus, countries have a valid defense out of stabilization clauses in case of any serious conflict arises between two contracting parties in oil and gas sector (Jacobi, Mittal and Weingast 2014).

Types of Stabilization Clauses in Oil and Gas Contracts

AGIP v Congo is a case law on breach of stabilization clause in oil and gas contracts which lead to illegal nationalization in Congo. In the said case, an oil and gas contract was executed between AGIP and Congo government (Oshionebo 2010). The parties choose the applicability of Congolese law along with international laws. The contract also contained a stabilization clause. However, irrespective of the same, Congo went ahead with nationalization of its oil fields. Thus, the issue in the said case was whether the Congo government’s action of nationalization was a valid breach according to the stabilization clause in the contract between the parties (Mohajeri 2013). The decision of the Court stated that the said nationalization was in breach of the stabilization clause and thus Congo was ordered to compensate the investors of the contract with the amount of damages and loss suffered by them. In another case LETCO V Liberia which was related to breach of stabilization clause, the Court upheld that nationalization which meant certain required criteria and qualification is justified (Roa 2013).

Thus, the success of stabilization clause depends entirely on how the clause is drafted and interpreted and most of the times, host countries and governments have valid defenses to get out of stabilization clauses using their constitutional and legal structure.

Reference List

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García-Castrillón, C.O., 2013. Reflections on the law applicable to international oil contracts. The Journal of World Energy Law & Business,6(2), pp.129-162.

Gehne, K. and Brillo, R., 2014. Stabilization Clauses in Interna-tional Investment Law: Beyond Balancing and Fair and Equitable Treatment (No. 2013/46, pp. 3-5). Working Paper.

Halabi, S., 2011. Efficient Contracting Between Foreign Investors and Host States: Evidence from Stabilization Clauses. Northwestern Journal of International Law & Business, 31, p.261.

Hogan, W., Sturzenegger, F. and Tai, L., 2010. Contracts and investment in natural resources. The Natural Resources Trap. Private Investment without Public Commitment, Cambridge u. a, pp.1-45.

Inkpen, A.C. and Moffett, M.H., 2011. The Global Oil & Gas Industry: Management, Strategy & Finance. PennWell Books.

Jacobi, T., Mittal, S. and Weingast, B.R., 2014. Creating a Self-Stabilizing Constitution: The Role of the Takings Clause. Nw. UL Rev., 109, p.601.

Kuznetsov, A.V., 2015. The Limits of Contractual Stabilization Clauses for Protecting International Oil and Gas Investments Examined Through the Prism of the Sakhalin-2 PSA: Mandatory Law, the Umbrella Clause, and the Fair and Equitable Treatment Standard. Willamette Journal of International Law and Dispute Resolution, 22(223).

Mato, H.T., 2012. Role of Stability and Renegotiation in Transnational Petroleum Agreements, The. J. Pol. & L., 5, p.33.

Mohajeri, E., 2013. Oil, Gas & Energy Law Intelligence.

Oshionebo, E., 2010. Stabilization clauses in natural resource extraction contracts: legal, economic and social implications for developing countries.Asper Rev. Int'l Bus. & Trade L., 10, p.1.

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Partlett, W., 2010. Enforcing oil and gas contracts without courts: Reputational constraints on resource nationalism in Russia and Azerbaijan.Demokratizatsiya: Journal of Post-Soviet Democratization, pp.74-93.

Roa, F.S.D., 2013. Investor-State Arbitration in Sovereign Debt Restructuring: The Role of Holdouts. Journal of International Arbitration,30(2), pp.131-154.

Sornarajah, M., 2010. The international law on foreign investment. Cambridge University Press.

Tienhaara, K., 2012. Foreign investment contracts in the oil & gas sector: a survey of environmentally relevant clauses. Sustainable Development Law & Policy, 11(3), p.6.