A Discussion On The Efficacy Or Otherwise Of Stabilisation And Renegotiation Clauses As Tools For The Management Of The Regulatory And Contractual Framework In A Production Sharing Agreement

This paper examines the use of stabilisation and renegotiation clauses as tools for the management of the regulatory and contractual framework in a Production Sharing Agreement. The usefulness and limits of both clauses are also considered and the efficacy of the renegotiation clause over the stabilisation clause as a means for the effective maintenance of the above mentioned framework is then highlighted by an examination of the way in which renegotiation clauses aim at balancing the interests of the parties whilst adapting to a change in circumstances surrounding the regulatory and contractual regime.

Oil and gas development regimes are often structured to attain the objectives of the host state which in the case of most developing countries is to secure the control over their hydrocarbon resources. Notwithstanding the existence of alternative models of oil and gas development regimes, the desire to exercise control over their hydrocarbon resources has been the principal reason for the preference by most developing countries to enter into Production Sharing Agreements (PSAs) with foreign oil companies whose principal goals are to protect their investments and make profit. Renegotiation clauses provide an avenue for the nullification of the potential balance of interests' problem posed by the insertion of stabilisation clauses in oil and gas contracts to the ability of parties to achieve their objectives under a Production Sharing Agreement.
As earlier mentioned, the choice of the oil and gas development regime a host state chooses to adopt is dependent on its objectives. Save for slight variations, there are essentially three petroleum development regime models a host state may choose from in establishing the structure of its oil industry. The first of these is the licensing or concession model. This is a system in which the host government grants permission to a company or a consortium of companies to conduct exploration and development activities, as well as conferring title to the licensee with respect to the hydrocarbon resources thereby produced. Under this system, the state receives compensation from the licensee in the form of royalties and taxes.
There also exists in addition to the above mentioned licensing model, a regime of petroleum development in which the state exercises complete control over its hydrocarbon operations. Under this system (more commonly referred to as a nationalised industry), the extent of foreign involvement is limited to the provision of services for a fee as the host state is in sole control of the management process and all the revenue accrues to the host state.
The Production Sharing Agreement (PSA) is another type of petroleum development regime which exists and it shall be discussed in detail below.

A PSA is a contractual arrangement in which a state (usually represented by its national oil company) engages the services of a foreign oil company to explore and produce petroleum within the host states territory. Under a PSA arrangement, the contractor bears all the exploration risks and if no oil is found, the contractor does not get compensated by the host state. In the event of a discovery, a certain percentage of the production usually referred to as 'royalty oil' is taken by the host state and the contractor recoups his costs through what is known as 'cost oil', after which the remaining production is split amongst the parties in already pre-determined proportions.
One very important point to be noted is that under a PSA arrangement, ownership of the produced hydrocarbon is vested in the state until the point in which production is split between the parties with the host state taking its royalty oil and its percentage of the profit oil and the contractor taking its cost oil along with its percentage of the profit oil.
A pertinent point for consideration at this juncture is the question of why PSAs are so attractive to developing countries. Developing countries seek to attain effective government control over the exploitation of their hydrocarbon resources. These countries in most cases however lack the financial and technical capability required to carry out exploration and development of hydrocarbons on a large scale. Their preference for PSA arrangements stem from the fact that PSAs are principally designed to attract foreign oil companies that are prepared to use their technical know-how and also risk capital in the development of a country's oil and gas reserves.
It should be pointed out that in most PSA arrangements, the National Oil Company (NOC) is expected to learn from the foreign oil company so that the oil and gas reserves can eventually be operated by the NOC in furtherance of the host governments desire to exercise control over their hydrocarbon resources. The PSA arrangement is thus very attractive to developing countries because from their point of view, they have nothing to lose as the risk of exploration is borne by the foreign oil company who accepts the prospect of its investment being lost in the event of no commercial discovery being made.
In addition to the above mentioned lack of risk on the host states part, the fact that ownership of the hydrocarbon extracted is vested in the state until the production is split between the parties are the principal factors behind the preference by developing countries of PSA's over other oil and gas development regime models.

Foreign oil companies often face a lot of risks in the conduct of their exploration and development activities. In addition to the technical and geological risks which foreign oil companies encounter, these companies are also confronted with a potential scenario in which the host state in furtherance of the exercise of its sovereign powers may decide to amend the administrative or legislative framework surrounding the agreement. The host state usually does this as part of its efforts in striving towards the attainment of its goal of effective government control over its hydrocarbon resources.
The underlying idea behind a stabilisation clause is that it limits the exercise of the administrative and legislative powers of the host state and consequently renders the host state incapable of unilaterally amending or modifying the agreed contractual regime whose terms are relied upon by the contractor. It essentially ties the hands of the host state during the subsistence of the oil and gas development contract so that the host state cannot interfere with the interests of an investor. In addition to ensuring the sanctity of the terms of the oil and gas development contract, stabilisation clauses also aim at preserving the rights and obligations of the parties in relation to acts that will be inimical to the fiscal and economic benefits derivable from the contract.
Stabilisation clauses act as safeguards for the protection of the legitimate expectations of the foreign investors by freezing the legislation of the host state and precluding the application of subsequent changes or amendments in the host states laws in relation to the petroleum development contract. They act as an important tool for the preservation of legal certainty and predictability of the regime which in turn promotes a more attractive investment climate as investors prefer clarity and the elimination of speculation.
Whilst the insertion of stabilisation clauses in oil and gas development contracts is primarily for the benefit of the foreign investor, stabilisation clauses are also beneficial to the interests of other third parties such as banks, insurance agencies and other financial institutions that may have provided financial backing to the investor. This is because it also provides these third parties with a sense of security in that they are guaranteed that there will not be any significant change to the contractual regime that will prevent the investor from making a return on the investment and consequently paying back the loan which it had obtained from the third party.
The importance of the inclusion of stabilisation clauses in oil and gas development agreements has also been emphasised in a number of arbitral decisions. In Parkerings v Lithuania, the arbitral tribunal stated as follows:
It is each State's undeniable right and privilege to exercise its sovereign legislative power. A State has the right to enact, modify or cancel a law at its own discretion. Save for the existence of an agreement, in the form of a stabilisation clause or otherwise, there is nothing objectionable about the amendment brought to the regulatory framework existing at the time an investor made its investment... The Claimant could (and with hindsight should) have sought to protect its legitimate expectations by introducing into the investment agreement a stabilisation clause or some other provision protecting it against unexpected and unwelcome changes.
Similarly, in Total v Argentine Republic, the tribunal stated that:
In the absence of some 'promise' by the host State or a specific provision in the bilateral investment treaty itself, the legal regime in force in the host country at the time of making the investment is not automatically subject to a 'guarantee' of stability merely because the host country entered into a bilateral investment treaty with the country of the foreign investor. The expectation of the investor is undoubtedly 'legitimate', and hence subject to protection under the fair and equitable treatment clause, if the host State has explicitly assumed a specific legal obligation for the future, such as by contracts, concessions or stabilisation clauses on which the investor is therefore entitled to rely as a matter of law.
The importance of stabilisation clauses as a tool for the protection of an investor's legitimate expectation was also highlighted by the tribunal in Impregilo v Argentine Republic as well as the EDF v Romania tribunal. Both tribunals were of the opinion that in the absence of specific representations in the form of stabilisation clauses, an investor was susceptible to the risk of a change in the host states legal and economic framework which might be detrimental to its interests.

International practice in relation to stabilisation clauses is not standardized and there consequently exist a number of variations to stabilisation clauses namely: stabilisation clauses in the strict sense; intangibility clauses and economic stabilisation clauses.
2.2.1 Stabilisation Clauses in the strict sense: This type of stabilisation clause seeks to ensure that the law applicable to the oil and gas development contract will not change over the duration of the exploration and production project. This is a more classic approach and such stabilisation clauses take a number of forms the most familiar of which is the freezing clause. In its strictest form, such a clause prohibits the host state from changing its laws that may be applicable to the oil and gas exploration and production contract and consequently creates an enclave arrangement for the foreign investor. Alternatively, such clauses may also seek to prevent the host state from applying subsequent changes in its law to the specific investment contract.
A stabilisation clause in the strict sense is consistent with the notion that legislation should not be retroactive.
2.2.2 Intangibility Clause: An intangibility clause prohibits the making of unilateral amendments to the investment agreement. Unlike the freezing clause which aims at indirectly restraining the state's legislative powers to subsequently make laws which will override those applicable at the time of entering the contract, intangibility clauses aim at limiting the state's capacity directly by requiring the mutual consent of the parties before amendments can be made to the contract.
2.2.3 Economic Stabilisation Clause: These are contract clauses that address stability through the economic re-balancing of the parties' obligations in the event of a post-contract measure which alters the parties expected fiscal benefits. Economic stabilisation clauses require the host state to refrain from enacting legislation or taking any administrative action which would occasion an increase in the cost of the project after the investment contract has been entered into. Alternatively, these clauses may also require the host state to restore the foreign investor's fiscal loss in the event of legislation which is adverse to the foreign investor's economic interests.
It is important to point out at this juncture that despite the earlier mentioned benefits and importance of stabilisation clauses, these clauses do not provide full protection against investment risks in a PSA. One of the constraints of stabilisation clauses is the fact that these clauses call into question the regulatory powers of the host state as a sovereign to make amendments to its legal and regulatory regime.
As a common principle of contract law, sanctity of contract is a generally accepted notion in most legal systems. However, the principle of sanctity of contract cannot be said to be absolute. As regards the exploitation of a host state's natural resources, the notion of sanctity of contract is overridden by the principle of permanent sovereignty over natural resources. Governments see oil and gas exploration and production agreements not merely as simple commercial agreements but as major instruments of public policy on which the country's socio-economic development depends. A potential solution to this problem for investors would be the insertion into the stabilisation clause of an express waiver of sovereign immunity and the host states right to nationalise. However, this is still not an absolute guarantee against the host states exercise of its sovereign powers.
Another constraint of a stabilisation clause is the effect of time elements on a PSA. Oil and gas exploration and production is a lengthy process and it is often based on assumptions. This consequently renders the PSA susceptible to outcomes which may be at variance with earlier assumptions and projections upon which the negotiations were based. When such a situation arises, the stabilisation clauses in PSAs are often circumvented so as to amend the terms of the agreement and ensure the workability of a contract the performance of which would otherwise be unfeasible.
In addition to the above discussed limitations to stabilisation clauses, their enforcement can also be fraught with difficulties due to the language used in the drafting of these clauses. Some stabilisation clauses contain provisions stating that neither party to the agreement may amend the terms thereof except by mutual consent of the parties. It should however be pointed out that the interpretation of the requirement of the mutual consent of the parties may be potentially problematic in a situation where there is no procedure envisaged by the parties as to how such consent would be given. This is because consent may either be express or implied and in the absence of a procedure for the determination of consent, a party who unilaterally amends the contract may argue that the other parties implied consent satisfies the requirement of the mutual consent of the parties.
This can be exemplified by a situation in which a host state takes the unilateral decision to increase royalty and tax rates contrary to the contractual terms and the foreign investor paid the new rates without expressing any reservation. In such a case, the foreign investors conduct may be held to be expressive of its implied consent to or acceptance of the host states unilateral decision.
The 2001 Mozambique model PSA is an example of a PSA agreement whose stabilisation clause does not prescribe any procedure for the determination of consent. The stabilisation clause in this model PSA states that:
The Government will not without the agreement of the contractor exercise its legislative authority to amend or modify the provisions of this Agreement and will not take or permit any of its political subdivisions, agencies and instrumentalities to take any administrative or other action to prevent or hinder the contractor from enjoying the rights accorded to it hereunder.
A solution to the above discussed potential problem would be the incorporation into the stabilisation clause of a procedure whereby the parties' mutual consent to an amendment would be given. This may be by expressly stating that the mutual agreement of the parties must be obtained in writing. The 2012 Cyprus Model PSA adopts this solution by providing that 'This Contract may be amended or modified only in writing and by mutual agreement of the Parties and with the approval of the Council of Ministers.' Similarly the 2008 Kenyan model PSA provides that 'This contract shall not be amended, modified or supplemented except by an instrument in writing signed by the parties.'
It is important to note at this point that stabilisation clauses may sometimes act as a shield for the government and a sword against the interests of a foreign investor. This can happen in instances where there are geological difficulties and a rise in operational costs which were unforeseen by the foreign investor. In such a scenario, the foreign investor may wish to amend the terms of the contract to mitigate some of the losses it might incur. The host state in this instance may then rely on the stabilisation clause as a shield to preclude the alteration of the terms of the agreement since the losses were not as a result of any amendment to the contractual or regulatory regime by the host state.
From all the above it can be seen that in reality, stabilisation clauses do not provide full protection against investment risks in a PSA. This is not to say that stabilisation clauses have lost their intrinsic value in a PSA as their insertion ensures that the investor is compensated in the event of a breach of these clauses by the host state. Furthermore, regardless of the above discussed limitations, the insertion of a stabilisation clause in a PSA still offers an enormous amount of protection to the foreign investor because the host state may be reluctant to breach the stabilisation clause in a PSA due to the wrong signals this may send to potential investors.
As previously mentioned, oil and gas exploration and development is a very risky venture. These risks are also accompanied by a high cost of investment and a lengthy period of time before which the investment begins to yield returns for the investor. Foreign investors usually seek assurances about the stability of an investment regime before committing capital to oil and gas exploration and development projects. Foreign investors require such assurances so as to guarantee that the financial premise and economies of the project will not be adversely affected by changes made by the host state and so as to ensure the realisation of the expected benefits of the investment project. Stabilisation clauses are the mechanism which foreign investors rely on to ensure the stability and predictability of the oil and gas development regime.
On the other hand, beyond the need to regulate an important industry, host states see their hydrocarbon reserves as a patrimonial inheritance belonging to the state and its future generations and which they must keep watch over. This consequently results in the host state being reluctant to allow the investor take a higher share of the economic rent or retain any excess profits. This is only possible by having a contract that can easily be amended to suit the needs of the host state.
The insertion of a stabilisation clause in a PSA thus creates a conflict of interests. Whilst the foreign investor relies on the stability and predictability of the regulatory and contractual regime in order to achieve its primary goal of a return on its investment, the host state on the other hand views the insertion of a stabilisation clause into the PSA as defeating its principal reason for adopting the PSA model which is to secure control over its hydrocarbon resources. The reason for the host states perception of stabilisation clauses in this manner is due to the fact that host states often seek to amend the regulatory and contractual framework surrounding the PSA agreement in order to keep it in line with the host states primary objectives but stabilisation clauses hinder such amendments from being made.
From the foregoing, it is evident that there exists a need to reconcile the interests of both the foreign investor and the host state by ensuring that their respective needs of stability and flexibility are met through the adaptation of the petroleum development contract to a change in circumstance, whilst also ensuring the maintenance of the economic equilibrium in the project and herein lies the importance of renegotiation clauses.

Renegotiation clauses are provisions in investment agreements that permit a review of the terms of the agreement by the parties upon the occurrence of certain events and with a view to adapting the investment agreement to these events. These clauses provide an avenue for the parties to an investment agreement to ensure the workability of a contract that would otherwise be almost impossible to honour if there was no opportunity to renegotiate and adapt the original contractual terms to a change in the circumstances surrounding the contractual regime. Renegotiation clauses are often provided for the benefit of both parties to the investment agreement although their implementation is often at the instance of the party whose contractual position will be weakened by an amendment to the contractual and regulatory framework.
There are a number of reasons why parties might possibly want to renegotiate the contractual terms of a PSA. From the foreign investors point of view, the need for renegotiation clauses in PSAs arise due to the fact that the decision to conduct hydrocarbon exploration at a particular location is based not on scientific certainty but on projections which are often hard to predict and when these projections are wrong, it is often to the detriment of the foreign investors especially in PSA arrangements which are structured to place the entire burden of risk on the investor. This coupled with the fact that oil and gas exploration and production agreements need to be concluded for very long periods with a continuing sequence of performance would render the terms of the investment very onerous to the foreign investor and thus necessitate the need for renegotiation of the terms so as to ensure the maintenance of the economic equilibrium of the project.
In addition to the above unforeseen and unregulated external events, foreign investors also seek renegotiation in instances where the imposition of obligations by the host state in the form of minimum investment requirements, infrastructure investment requirements and obligations to sell production domestically below the market prices result in a situation where the minimum financial return from the project can no longer be realised.
On their part, host states have sought to take advantage of the renegotiation clauses in PSAs by seeking an amendment to the fiscal regime in situations where the original equilibrium has been disrupted by external events such as a significant increase in oil prices and the foreign investor has made a much higher return on its investment than initially anticipated. The need for host states to renegotiate the investment agreement in such instances stem from the earlier mentioned fact that host states always seek to ensure that investment contracts remain in furtherance of the states objectives which in the case of most PSAs is to enable the exercise of control by the state over its hydrocarbon resources and the benefits derivable therefrom.
Another reason why parties to an investment agreement tend to have an interest in renegotiation clauses is due to the fact that the breakdown of an investment project can be potentially detrimental to the reputation of both parties. On the host states part, it may lead to a deterioration of its investment climate as potential investors may be scared off due to a rise in the states political risk rating. The foreign investor on the other hand may find itself being criticised by the industry with questions being asked about its management capabilities and this may hinder its ability to raise capital for future projects.
Renegotiation clauses thus offer parties an early opportunity of settling differences before they become irreconcilable. To this extent, renegotiation clauses can be viewed as the first step in the dispute resolution mechanism, which provides a consensual means for both parties to adapt the investment agreement to changing circumstances whilst maintaining their contractual benefits.
At this juncture, it is important to mention that even though a renegotiation clause in a PSA offers flexibility to both the host state and the foreign investor, the principal significance of a renegotiation clause is in the balance it offers between the investor's primary need for stability and the host states flexibility requirements. This is so because by permitting the exercise by the host state of its administrative and regulatory powers, renegotiation clauses ensure that the host states sovereignty is preserved while at the same time safeguarding the interests of the foreign investor by allowing a renegotiation of the investment contract with the aim of maintaining the initial financial premise of the project.
Renegotiation clauses can be classified into three main categories namely: limited renegotiation clauses, hardship clauses and wide renegotiation clauses. Limited renegotiation clauses are also known as specific renegotiation clauses while the other two classifications are more commonly referred to as general renegotiation clauses.
3.2.1 Limited Renegotiation Clauses: A limited renegotiation clause is one in which the circumstances which trigger the renegotiation duty are clearly defined. The insertion of a limited renegotiation clause in a PSA presupposes the fact that both parties knew from the beginning that certain contractual terms were liable to potential changes. Such clauses contain provisions which explicitly mention the factors that should be taken into consideration when the parties seek to renegotiate the terms of the investment agreement.
3.2.2 Hardship Clauses: These are clauses which have a much broader ambit than the limited renegotiation clauses. Under this type of renegotiation clauses, the triggering event is not as precisely defined as that under a limited renegotiation clause and there are no indications as to which contractual terms might be liable to change and in what manner.
3.2.3 Wide Renegotiation Clauses: Wide renegotiation clauses are clauses which are broader in scope than hardship clauses. Under this type of clauses, the triggering event is neither described nor the potential scope of renegotiation discussed in further detail.
Renegotiation clauses have a number of limitations which sometimes hinder their effectiveness. These limitations depend on the nature of the renegotiation clause in question. One limitation which applies to renegotiation clauses of a general nature (hardship clauses and wide renegotiation clauses) is the fact that the definition of the 'trigger event' is often very broad and leaves a lot of room for uncertainty. The efficacy of a renegotiation clause in practice is primarily dependent on the prerequisites for initiating a consensual procedure being clearly defined in the clause. The open ended nature of general renegotiation clauses is therefore incongruous given the above explained need for concrete definitions.
Foreign investors in particular, have concerns that hardship clauses can lead to contractual instability and provide the host state with a potential means of evading its contractual obligations. This concern by foreign investors is due to the imprecision of the term 'hardship' and the loosely defined triggering events which investors fear may encourage the advancement of dubious claims on grounds of the existence of hardship in order to excuse contractual non-performance. An examination of the 2003 International Chamber of Commerce (ICC) Hardship Model Clause shows that this concern by foreign investors is not too farfetched. The ICC Hardship Clause provides that:
1. A party to a contract is bound to perform its contractual duties even if events have rendered performance more onerous than could reasonably have been anticipated at the time of the conclusion of the contract.
2. Notwithstanding paragraph 1 of this Clause, where a party to a contract proves that:
a) the continued performance of its contractual duties has become excessively onerous due to an event beyond its reasonable control which it could not reasonably have been expected to have taken into account at the time of the conclusion of the contract; and that
b) it could not reasonably have avoided or overcome the event or its consequences, the parties are bound, within a reasonable time of the invocation of this Clause, to negotiate alternative contractual terms which reasonably allow for the consequences of the event.
3. Where paragraph 2 of this Clause applies, but where alternative contractual terms which reasonably allow for the consequences of the event are not agreed by the other party to the contract as provided in that paragraph, the party invoking this Clause is entitled to termination of the contract.
Specific renegotiation clauses also have their own constraints. These constraints stem from the fact that the trigger for renegotiation in such clauses is linked to the occurrence of one or more events which are precisely defined in the clause. These events may be tax increases, a change in economic conditions, price changes for raw materials or a range of other issues. While such specific clauses are advantageous from the perspective of unambiguousness in that they precisely determine the trigger events for renegotiation, the constraint to such clauses is in the fact that only a very limited number of circumstances would warrant a variation of the terms of the contract no matter how onerous the performance of the terms of the contract turns out to be after the agreement has been executed.
It should however be noted at this point that in practice, the distinction between specific and general renegotiation clauses can sometimes be blurred as overlaps could exist between these clauses. Reference to the Liberian model PSA shall illustrate this point. The renegotiation clause in this model PSA states as follows:
In the event of changes in circumstances from those existing at the Effective Date, that have a significant material effect on the terms of this Contract, either NOCAL or the Contractor shall at the request of the other consult together. If it mutually established that such Profound Changes in Circumstances have occurred, then the Parties shall effect such changes in or clarifications to this Contract that they mutually agree are necessary... 'Profound Changes in Circumstances' shall mean such changes in the economic conditions of the petroleum industry worldwide or in Liberia or such changes that result in such a material and fundamental alteration of the conditions and assumptions relied upon by the Parties at the Effective Date of this Contract (or the time after any subsequent review under this Article) to the effect that the overall balance of equities and benefits reasonably anticipated by the Parties will no longer be achievable.
From the above, it is evident that there are overlaps in the nature of the definition of the trigger events in this renegotiation clause. On one hand, the trigger events appear to be specific when reference is made to 'changes in the economic conditions of the petroleum industry'. The trigger events are however subsequently further defined to include the vaguely described 'changes that result in such a material and fundamental alteration of the conditions and assumptions relied upon by the parties' and it could be argued that this subsequent definition is of a general nature. While it is impossible to get into the psyche of the drafters of this renegotiation clause, one possible explanation is that the drafters in view of the above discussed limitations of both specific and general renegotiation clauses sought to strike a balance between the generality and the specificity of the renegotiation clause.
Another constraint to the efficacy of renegotiation clauses in practice is the uncertainty surrounding the options available to the parties in the event of a failure to reach an agreement. Some renegotiation clauses particularly hardship clauses regulate this issue explicitly. For instance the earlier mentioned ICC Hardship Model Clause provides for a right to terminate the agreement in the event of a failure to reach alternative contractual terms. However, not all renegotiation clauses contain provisions addressing this issue and a number of questions arise in relation to such clauses. Will the contract stay as it is, will it be terminated, or will it be adapted by a third party such as an arbitral tribunal? In other words, can the obligation to renegotiate be interpreted to mean an obligation to agree? These are some of the uncertainties which come about as a result of the failure of the renegotiation clause to address this issue.
In Kuwait v Aminoil, the arbitral tribunal stated that where there is an obligation to negotiate, there are four general principles that should be observed and these are as follows:
[T]he negotiations are to be carried out in good faith as properly understood; there is to be a sustained upkeep of the negotiations over a period appropriate to the circumstances; there is to be awareness of the interests of the other party; and there should be a persevering quest for an acceptable compromise.
The tribunal also laid emphasis on the fact that an obligation to negotiate is not the same as an obligation to agree. It can therefore be seen that with the exception of hardship clauses of the type mentioned above, renegotiation clauses do not provide for the consequences of a failure to reach an agreement. They only require parties to do their utmost best to reach an agreement within the framework of the above presented criteria and do not however impose mandatory obligations on the parties to actually reach such an agreement.
It should however be noted at this point that despite all the above mentioned limitations, the ability of renegotiation clauses to balance the interests of the parties whilst adapting to a change of circumstance make them a more practical means than stabilisation clauses in the management of the regulatory and contractual framework of a PSA and this shall be shown in the chapter below.

As mentioned in the preceding chapters, stabilisation and renegotiation clauses are tools employed by host states and investors in the management of the regulatory and contractual framework of a PSA. However, a major shortcoming of stabilisation clauses and one which raises doubts in relation to its ability to manage the above stated framework is the earlier mentioned fact that hydrocarbon exploration and production is a lengthy process involving assumptions which may eventually turn out to be incorrect and thus create a very unfavourable situation for one of the parties. When such a situation arises, the stabilisation clauses in the PSA would compel the performance of the terms of the contracts regardless of how onerous those terms are and this could eventually lead to a total breakdown of the investment project as the party to whom these terms are detrimental to will be unwilling to see out the entire duration of the agreement on such onerous terms.
On the other hand, the renegotiation of investment agreements as a path leading to the repositioning of its equilibrium over time has been shown to be an absolute necessity if an investment agreement is to survive the change in circumstances surrounding it. Renegotiation clauses try to offer a contractual framework that reflects the parties' needs for renegotiation by providing a controlled path under which such unavoidable renegotiations are to take place. The efficacy of the renegotiation clause over the stabilisation clause therefore lies in its ability to balance the interests of the parties whilst maintaining the economic equilibrium of the project.
Admittedly, renegotiation clauses have their limitations. This does not however take anything away from the fact that they remain a more effective and practical means in the management of the regulatory and contractual framework in a PSA as their limitations have a number of potential solutions.
The respective difficulties associated with loosely and narrowly defined 'trigger events' in general and specific renegotiation clauses can be overcome by drafting the clause in a such a way that an adequate balance is struck between the generality and specificity of the trigger events. In this regard, the drafters of the renegotiation clause in the earlier mentioned Liberian Model PSA must be commended for their efforts in drafting a clause which seeks to strike this balance.
As regards the inability of a renegotiation clause to actually compel the parties to reach an agreement, this problem can be solved by the insertion of an obligation to adapt the contract so that the failure to reach an agreement within a specified time limit would not only constitute a breach of this duty, but could also be remedied by a court or an arbitral tribunal. The implications of such an obligation to adapt will be two-fold. First, it would have the effect of transposing the obligation to renegotiate to an implied obligation to agree as the apprehension of the dispute being taken before an arbitral panel whose decision might not be favourable to either or both parties could act as an incentive for parties to reach a compromise. Secondly, such an obligation to adapt the contract reduces the ability of parties to hold the renegotiation to ransom as parties are aware of the fact that a dispute must be declared at the expiration of the time limit.
It is however important to note that the provision relating to third party adjustment should clearly state the parties intentions of transferring to the tribunal this sort of creative competence which goes beyond normal dispute adjudication. In Kuwait v Aminoil, the tribunal expressly stated this point thus:
There can be no doubt that, speaking generally, a tribunal cannot substitute itself for the parties in order to... modify a contract unless that right is conferred upon it by law, or by the express consent of the parties... arbitral tribunals cannot allow themselves to forget that their powers are restricted. It is not open to doubt that an arbitral tribunal - constituted on the basis of a 'compromissory' clause contained in relevant agreements between the parties to the case... ' could not, by way of modifying or completing a contract, prescribe how a provision such as the Abu Dhabi Formula must be applied. For that, the consent of both parties would be necessary.
Parties seeking to insert renegotiation clauses in PSAs should therefore take heed of the above discussed means of circumventing the limitations to these clauses as this will ensure that these clauses will fulfil the expectations of the parties in relation to the management of the PSAs framework.
At this juncture, it is important to highlight one of the most notable instances of petroleum contract renegotiations to have occurred in recent times as this will help in achieving a better understanding of the near impracticability of stabilisation clauses and lead to a greater appreciation of the benefits of a renegotiation clause.
This case study involves the renegotiation of the PSA covering the Kashagan oilfield in Kazakhstan which is the world's largest discovery since Prudhoe Bay in Alaska in 1968. The underlying issue which needed redress by means of renegotiation was the concept of cost recovery under which a significant percentage of production (80%) was allocated as cost oil in order to facilitate the recovery by the contractors of their expenditure. After the apportionment of that 80% to the contractor, the remaining production (profit oil) was then to be split between the contractor and the state with the contractor taking 90% and the state taking 10%. This ratio was however to change in favour of the state in the long run based on a number of complicated triggers which were included in the investment agreement.
However, until these trigger events occurred, the contractor would continue to receive 80% of the cost oil and 90% of the profit oil and this amounted to about 98% of total production while the state on the other hand would only be entitled to a meagre 2% of the total production (not including the relatively small participation of a subsidiary of the national oil company in the contractor consortium). After the agreement had been entered into, the Government on hindsight realised that they had seriously short-changed themselves. However, the final straw which broke the camel's back was the delays in production due to technical challenges encountered by the contractor which increased the estimated total for the project by more than 100 billion dollars. These delays also meant a delay in the benefits which the government was expecting from the agreement as the date for the production of first oil was postponed till 2013. These delays provided the government with a platform to launch the renegotiation of the terms of the agreement without causing a major outcry from the investors.
In the renegotiations that followed, the state's share of total production increased to 3.5% with the possibility of rising to as high as 12.5% depending on rises in the price of crude oil, the state oil company's subsidiary doubled its stake in the project, a new priority share was allotted to the state and new cost and schedule control mechanisms were introduced to help prevent a re-occurrence of the sort of cost increases and delays which were previously encountered.
A common denominator in most renegotiation instances is the fact that there is a significant alteration to the initial assumptions behind the original agreement and this paradigm shift leads to a situation in which the survival of the contractual relationship becomes dependent on the renegotiation of the terms of the contract. In the Kashagan case, technical issues encountered by the contractor led to a delay in production and this was a change in the assumptions behind the agreement as this meant that the government lost some expected revenue as a result of the delayed production.
The above case also highlights the fact that in the pursuit of an effective mechanism for the maintenance of the regulatory and contractual framework in PSAs, stabilisation clauses are nothing more than Potemkin villages. Stabilisation clauses do not operate in consonance with the realities of investment agreements in the oil and gas industry which are often unpredictable due to a host of geological and technical issues and which inevitably require a renegotiation of the initial terms.
In the light of the fact that the efficacy of stabilisation clauses is highly doubtful, renegotiation clauses can actually offer protection against unilateral revocation or modification by the state. In fact, the use of renegotiation clauses in oil and gas exploration and production contracts could potentially contribute to the transactional stability sought by foreign investors. This is due to the fact that under a renegotiation clause, a state enters into a binding obligation to renegotiate the terms of the agreement in the event of the occurrence of a supervening state of affairs rather than revoking or altering the terms of the agreement by unilateral action. Thus, renegotiation clauses have the ability to play a facilitative role in the stabilisation of PSAs and other long term oil and gas exploration and development contracts which are inherently unstable by their very nature.
There exists a school of thought which suggests that legal constructions possess little significance since they lack the ability to contain the pressure for contractual change. This view however overlooks the critical fact that effective legal provisions such as renegotiation clauses may indeed not necessarily prevent contractual change from taking place, but nevertheless remain invaluable in terms of bargaining positions and remedies which they confer on parties if a unilateral alteration to the terms of the agreement bears, economic, political or judicial consequences. In a properly drafted renegotiation clause, the failure to reach an agreement following such a unilateral alteration to the terms of the contract will lead to the intervention of an arbitral tribunal which will have the power to adapt the contract to try and restore the contractual equilibrium thereby balancing the interests of the parties.
The conflict in international law between the sovereign prerogative of the state on the one hand, and the sanctity of agreements on the other appears to have been settled by the widened usage of renegotiation clauses. International tribunals have generally tended to side with contract renegotiations when fundamental change in circumstances occur. Despite arguments by those in favour of the strict stability of international investment agreements, international practice in this area has increasingly favoured the periodic renegotiation of such agreements. Thus unlike stabilisation clauses, renegotiation clauses have the added advantage of satisfying the states desire to preserve its sovereign prerogatives.
The use of renegotiation clauses also come in handy in instances where the parties by virtue of their differing cultures, interpret and perceive the basis of the petroleum exploration and development contract in fundamentally different ways. For instance, the Asian business style completely differs from that obtainable in the West. In the Asian context, business executives often seek the avoidance of disputes when feasible, and seldom seek to discard of the relationship even in times of disagreements as they consider the relationship between the parties to be the essence of a business deal. The Asian business style operates on the premise that long-term business relationships impliedly provides an obligation on parties in times of changes to meet and decide together how their relationship can be adapted to cope with the new circumstances surrounding it. On the other hand, Westerners (Anglo-Saxons in particular) often perceive agreements as being wholly contained in a lengthy and detailed contract which leaves little room for variation except in very specific circumstances.
In the event of the entry into a long term petroleum exploration and development contract between parties belonging to different cultures as illustrated above, the differences which may arise should be anticipated and an effort should be made in bridging these gaps by finding a middle ground which satisfies both parties. In the search for a middle ground in instances such as the above, renegotiation clauses appear to be the answer as they stand right at the midpoint between complete relational flexibility and total contractual rigidity thus balancing the interests of the parties.
The importance of the ability to renegotiate to the survival of long term oil and gas exploration and production contracts cannot be over emphasised. Another indicator of the importance of renegotiation in such contracts is the fact that arbitral tribunals in some instances have even been willing to endorse the renegotiation of such investment agreements despite the renegotiation not being in conformity with the provisions of the investment contract. For instance, in Mobil Oil v Iran, the tribunal held that the duties and obligations of the parties under the investment agreement in dispute had to be construed not only pursuant to the initial contract terms, but also in accordance with the manner in which the contract was performed and the de facto or de jure amendments during it subsistence. The tribunal accordingly upheld the validity of the investment agreement despite the informal changes to the initial agreement.
Also, the United Nations Economic and Social Council (ECOSOC) Draft Code of Conduct on Transnational Corporations makes provisions for certain instances in which transnational corporations should engage in renegotiation of investment agreements with governments even in the event of a lack of a relevant clause and such instances include where there is a clear inequality between the parties, where the conditions upon which the contract was based have fundamentally changed or where there is duress involved. Although it was never finalised as a legal instrument, the draft code is still of normative value and reference to the renegotiation provision in the draft code further emphasises the point that renegotiation is an indispensible tool in international commercial contracts.
The International law doctrine of rebus sic stantibus also appears to lend credence to the principle of renegotiation of contracts in the event of a fundamental change of circumstances. This principle is enshrined in Article 62 of the Vienna Convention albeit with limited application and although the Vienna Convention is only applicable to agreements between states, an analogy can however be drawn from this as it has been argued that Article 62 presents a strong case for the existence of a general legal principle which might also be relevant to transnational contracts such as petroleum investment agreements with or between private parties.
From the preceding discussions, it is evident that one re-occurring theme which is crucial to all the above mentioned arguments in favour of the continued usage of renegotiation clauses is the ability of such clauses to balance the interests of the parties in the event of a fundamental change of the circumstances surrounding the agreement and this remains the strongest argument in favour of the use of renegotiation clauses over stabilisation clauses.
Undoubtedly, from the point of view of developing countries, PSAs still remain the most attractive petroleum development regime model. However, in the quest for the maintenance of the contractual and regulatory framework of such agreements, parties have occasionally resorted to the use of stabilisation clauses which come with the long term problem of trying to balance the foreign investors primary need for a stable and predictable regime with the governments need for flexibility of the regime in order to constantly keep the contract in line with its objectives of exercising control over its hydrocarbon resources. As has been shown in the previous chapters, renegotiation clauses provide an avenue for the nullification of the potential balance of interests' problem posed by the insertion of stabilisation clauses in oil and gas contracts to the ability of parties to achieve their objectives under a PSA.
This is however not to say that there are no challenges posed by the use of renegotiation clauses. As highlighted in preceding chapters, problems could potentially arise in relation to the scope and the definition of the trigger events for renegotiation. Where the trigger events are broadly worded, a lot of room for uncertainty is created. On the other hand, where the trigger events are very specific, then only the occurrence of those specified events can trigger a renegotiation irrespective of how onerous the contract terms are. Also the efficacy of renegotiation clauses is constrained by the fact that most renegotiation clauses do not actually compel the parties to reach an agreement.
Thankfully, parties wishing to insert renegotiation clauses in their PSAs can overcome these constraints by paying attention to a number of considerations the first of which is drafting the clause in such a way as to obtain an adequate balance between the generality and the specificity of the trigger events. Also parties would best be advised to insert a clause granting power to an arbitral tribunal to adapt the contract in the event of a failure to reach an agreement on renegotiated terms within a specified time limit.
During its subsistence, an oil and gas exploration and development contract can raise a number of complex issues. In the absence of a renegotiation clause, these complexities can force the premature demise of an arrangement that could potentially continue to benefit the parties as experience has shown that renegotiation is a way of life in long term business agreements such as oil and gas exploration and development contracts which depend on a series of continuing performances by both parties. Internationally and generally accepted legal principles have also recognised the right of a party whose participation in a contract has become arduous through no fault of its own, but through the collapse of basic circumstances underlying the contract with a major disruptive effect on the balance of benefits, to seek a renegotiation of such contractual commitments.
Despite their limitations, renegotiation clauses for now remain the most effective mechanism in the management of the contractual and regulatory framework of a PSA and they also remain the most viable solution to the problem which arises from the conflicting stability and flexibility requirements sought by the parties to a PSA. Until the industry comes up with a more effective method of dealing with this problem, renegotiation clauses shall continue to be relied on by the drafters of PSAs as the most practical means of achieving this balance of interests.

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