Stabilisation And Negotiation Clauses

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.

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