Economic Stability and Change of Law provisions in a PSC

A paper by Rajat Kapoor (dtd 23 August 2010)

The use of stabilization clauses is a direct response to material changes in legislation that altered the economic positions of foreign companies under previously concluded long term investment agreements. Investors rely on stabilization clauses to ensure relative stability of the main investment conditions needed for the successful performance of their investment ventures. For the foreign investors and their bankers, stabilization concerns among other things, the stability of the fiscal regime to ensure investment recovery, security of tenure over property and title, the ability to sell, the ability to retain and repatriate foreign exchange earned and the ability to operate the project under reasonably foreseeable conditions. Foreign Investors would also be concerned about non financial matters like changes in labour and environmental law or changes in the interpretation of the existing law to the extent that it affects their interests adversely. In the period between the first and second world war, American companies began to include stabilization clauses in the concession contracts to prevent acts of nationalization by Latin American governments. Stabilization Clause can be primarily of 2 types: 1. Freezing provision 2. Economic Balance provision

1. Freezing Clause : It stipulates that neither the fiscal, nor the non-fiscal elements (social & environmental issues) of the contract may be changed by the host government during life of the contract without the two parties consent (Angola, Tunisia, Mozambique etc) . Examples: a. Cl 30.7(d) Mozambique PSC Model (2001) : The Government shall not revoke or amend the Autorisation granted to ENH to explore for and produce Petroleum from the contract Area without taking effective measures to ensure that such revocation or amendment does not affect the rights granted to the Contractor hereunder CL 30.7(e) 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 instrumentalies to take any administrative or other action to prevent or hinder the contractor from enjoying the rights accorded to it hereunder. b. Cl. 18(m) Ivory Coast 1996 Petroleum Code The petroleum contract in particular must set. The legal conditions concerning the applicable law, the stability of conditions, the cases of force majeure and the regulation of disagreements
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c. Cl. 24.1 Tunisia 1989 PSC Model The contractor shall be subject to the provisions of this Contract as well as to all laws and regulations duly enacted by the Granting Authority and which are not incompatible or conflicting with the Convention and/or this Agreement. It is also agreed that no new regulations, modifications or interpretation which could be conflicting or incompatible with the provisions of this Agreement and/or the Convention shall be applicable 2. Economic Balancing Clause Essentially, the provision stipulates that if the host government adopts a measure subsequent to the conclusion of the petroleum contract in which the fiscal terms are stated, that is likely to have damaging consequences to the economic benefits for one or both parties, a re-balancing will take place in order to restore the economic balance of the contract. Two (2) ways to achieve the economic balance: i. ii. Adjustment may be automatic or achieved in a manner stipulated in the contract. Make express provision for the parties to negotiate how amendments should be handled

Examples of this are Vietnam, India, Indonesia, Egypt etc. a. Vietnam PSC Cl 18.1.3 If after the Effective Date, existing law(s) and regulation(s) are amended or annulled or new law(s) and regulation(s) are introduced in Vietnam, or an official interpretation or application of changes of regulations of a law, or licence is cancelled, not renewed, or the conditions therefore are revised adversely affecting the economic interest of the CONTRACTOR under this Contract, then upon notice from the CONTRACTOR the Parties shall consult promptly with each other and make such changes to this Contract as are necessary both to maintain the CONTRACTORs rights, benefits and interests hereunder, including CONTRACTORs share of Profit Oil or Profit Gas, as at the Effective Date and to ensure that any revenues or incomes or profits, including any one or more of the foregoing, derived or to be derived to the CONTRACTOR under this Contract, shall not in any way be diminished in comparison to that which was originally contemplated as a result of such changes of laws or annulment therefrom or their interpretation or application or as a result of such changes, cancellation or non-renewal of approvals or licences b. Egypt Exploration, Development and Production of Petroleum, which take place after the Effective Date, and which significantly affect the economic interest of this Agreement to the detriment of CONTRACTOR or which imposes on CONTRACTOR an obligation to remit to the Arab Republic of Egypt the proceeds from sales of CONTRACTORs Petroleum, CONTRACTOR shall notify EGPC (the NOC) of the subject legislative or regulatory measure. c. Indonesian PSC Cl 15.4.3 It is agreed further in this CONTRACT that in the event that a new prevailing Indonesia Income Tax Law comes into effect, or the Indonesia Income Tax Law is changed, and CONTRACTOR becomes subject to the provisions of such new or changed law, all the percentages appearing in Section VI of this CONTRACT as applicable to the portions of CONTRACTOR and GOIs share so affected by such new or changed law shall be revised in order to maintain the same net income after tax for CONTRACTOR or all Participating Interest Holders in this CONTRACT
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d. Indian PSC Cl 17.10. If any change in or to any Indian law, rule or regulation dealing with income tax or other corporate tax, export/import tax, excise, customs duty or any other levies, duties or taxes imposed on Petroleum or dependent upon the value of Petroleum results in a material change to the expected economic benefits accruing to any of the Parties after the date of execution of the Contract, the Parties shall consult promptly in good faith to make necessary revisions and adjustments to the Contract in order to maintain such expected economic benefits to each of the Parties, provided, however, that the expected economic benefits to the Parties shall not be reduced as a result of the operation of this Article.

In the early 1980s, revision of petroleum contracts and nationalisation of petroleum industry assets triggered confrontational arbitration procedures: a few cases: Saudi Arabia v. Arabian American Oil company (Aramco) Kuwait v. American Independent Oil Company (Aminoil) Agip Company v. Peoples Republic of the Congo Amoco International Finance Corporation v. Islamic Republic of Iran. National Oil Companies (NOCs) and the Contract Stability

It is important to note however that there are many petroleum rich host countries that do not offer clauses designed to provide STABILIZATION and that IOCs have no difficulty living with such a legal regime, as the legal and political risks are low in those host countries (UK, Norway are few examples). In other countries, while the legal and political risks may be high, the perception of the geological risk is so low that IOCs accept a contract without stabilization provisions (Saudi Arabia, Brazil are some examples).

Annexure I Moderate Form of the freezing Clause

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In practice it is rare especially in recent times for host governments to agree to an absolute freezing of contract terms which permanently protects the parties rights and obligations agreed in the contract such that subsequent changes to the law of the host state would not be applicable to the particular contract for the duration of its term Ghana: Article 26 of The Petroleum Agreement of 22 July, 2004, among the Republic of Ghana, Ghana National Petroleum Corporation, Kosmos Energy Ghana HC and the EO Group in respect of West Cape Three Points Block Offshore Ghana, contains an interesting mix of stabilisation clauses. It stipulates at paragraph 2: The State, its departments and agencies, shall support this Agreement and shall take no action which prevents or impedes the due exercise and performance of rights and obligations of the Parties hereunder... Also Article 26.3, which reads: This agreement and the rights and obligations specified herein may not be modified, amended, altered or supplemented except upon the execution and delivery of a written agreement executed by the Parties. Any legislative or administrative act of the State or any of its agencies or subdivisions which purports to vary any such right or obligation shall, to the extent sought to be applied to this agreement, constitute a breach of this agreement by the State; provided, however, if the Petroleum (Exploration and Production) Law, 1984 (PNDCL 84) is amended or replaced (superseded), Contractor shall be entitled to enjoy and this Agreement (and any new petroleum agreement referred to herein) shall be deemed to include the terms and conditions in such amendment or replacement law that favourably affect the rights and/or obligations of the Contractor under this Agreement. The Kosmos Energy agreement also contains an Equilibrium or Economic Balancing Clause. Unlike the freezing clause, this clause does not seek to restrain the host government from altering the PSC terms but seeks to mitigate any adverse economic impact of such changes on the company. Thus, Article 26.4 of the Kosmos Energy agreement reads in part: Where a Party considers that a significant change in the circumstances prevailing at the time the Agreement was entered into, has occurred affecting the economic balance of the Agreement, the Party adversely affected thereby shall notify the other Parties in writing of the claimed change with a statement of how the claimed change has affected such economic balance If such significant changes are established by the Parties to have occurred, the Parties shall meet to engage in negotiations and shall effect such changes in, or rectification of, these provisions as they may agree are necessary to restore the relative economic position of the Parties as at the date of this Agreement. The equilibrium or economic balancing clause takes the form that in the event that the host government takes an action that has a negative impact on the economic benefits of the IOC under the contract, there would be an attempt at re-balancing to bring the parties back to the status-quo ante. This re-balancing may be done through negotiation or in some cases may occur automatically. The clause, as in the Kosmos Energy case, includes an option to resort to arbitration in the event that the parties fail to reach an agreement within a stated time frame

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