International Oil and Gas Industry Disputes
This article gives an outline of the kinds of disputes that arise in the international oil and gas industry. The subject is potentially encyclopaedic in scope, so for an article of this kind I have had to be selective. My aim has been to give practitioners in Russia whose main focus is on general commercial practice (who have limited familiarity with activities of the international oil and gas industry), with a general overview of those aspects of the international oil and gas industry where a general practitioner might not be aware of particular issues that commonly arise in the legal affairs of the industry or where the practice of the international industry is materially different from that in Russia.
I have tried to do this in broad generic terms without going into detail or highlighting “latest” developments. Inevitably, this selection of subject matter is to some extent subjective and reflects my own experience and interests. However, in characterizing the areas in which disputes arise, I have kept in mind the topics covered by the joint conference put on the Association of International Petroleum Negotiations (AIPN) and London Court of International Arbitration (LCIA) conference on “Dispute Resolution in the Oil and Gas Business” in London in October 2018 and the similar conference they put on three years earlier. My focus is mainly on upstream – i.e. exploration and production – activities, as well as other related activities (e.g. oil and gas sales).
I have been more discursive with the first two topics - which fall under public international law – because they are likely to be less familiar to the general practitioner and therefore merit greater elucidation. By its nature, public international law is the same in Russia as everywhere else, but unless a practitioner has been engaged in matters involving public international law (or studied it as university) it is likely to be less familiar than the areas normally dealt with in commercial practice.
I would note for Russian readers that the way the international oil and gas industry is structured and regulated in Russia is different from that in many other parts of the world. Each country, of course, has its own laws and legal practices but the way of doing things in the international oil and gas industry has been greatly influenced by US and – especially – UK practice because so many of the global players have been engaged there.
Boundary Disputes between States
Disputes over the land boundaries of states are as old as mankind. Boundaries in western Europe have been stable since the Treaty of Versailles (1919), while those in central and eastern Europe have been anything but so. Nonetheless, since WW2, the main oil and gas producing regions there have lain in places that are relatively remote from disputed areas. The break-up of the former Soviet Union into new states was relatively peaceful and the main oil and gas producing areas were little affected by disputes over boundaries, although there have been exceptions in Georgia and Crimea. These disputes however have involved major political issues of a kind that go much wider than boundary determination through legal processes. These may, of course, come into play at a future stage if the broader issues are resolved. The area where there have been issues within the former Soviet Union that might be resolved in this way concern the delimitation boundaries within the Caspian Sea, which is problematic because, being wholly enclosed, it is not subject to international public law of the sea (about which, see below) and, on the other hand, the countries concerned have been reluctant to treat it merely as a lake. Nonetheless, they have come to practical resolution (in some cases by bilateral agreements between adjacent states) that has enabled exploitation to take place in areas that would clearly belong to one country or another if a full delimitation were achieved (particularly in areas offshore Kazakhstan, Russia and Azerbaijan) and they may also be well on the way to resolution in the remaining areas.
However, the situation in many other parts of the world – especially the Middle East, Africa and Asia – in many cases have involved legal as well as political processes. In some cases – such as in the Empty Quarter of the Arabian quadrilateral - the boundaries have been ill defined because in the past there was no need to define them and the area was in common use by different tribes. In others, particularly where states have split up or otherwise been separated into different new states, the situation has been more complex. Settling such disputes involves reviewing historical antecedents and usage as well as geography. The situation inevitably becomes more complicated – and focus on the issues more intense – once oil or gas (or other valuable minerals) is found. It is, in practice, possible to exploit such resources without challenge in areas where there is unlikely to be any adverse claim. It is different, of course, where such a claim is likely or active.
In North America, the landward boundaries were settled in the 19thcentury. However, delimitation of seaward boundaries has been a different matter and initiated the development of public international law described below.
By contrast with the landward situation, the legal regime relating to offshore boundaries – particularly as regards the continental shelf - is relatively new. It began in 1945 when President Truman declared publicly that the United States intended to exploit the natural resources of the continental shelf beneath the seas contiguous to its coasts. The focus was particularly on the Gulf of Mexico, which is very rich in oil and gas deposits. Many nations joined in subsequently to assert claims in respect of their own continental shelf areas, and it quickly became evident that some sort of resolution was needed which would be effective in public international law. An International Law Commission worked between 1951 and 1958, and the United Nations held its first conference on the law of the sea in Geneva, Switzerland. This resulted in four treaties in 1958 which covered a broad range of public international law issues relating to the law of the sea and together constituted the Convention on the Continental Shelf. It had a high level of adherence amongst the major coastal states (although some registered reservations, i.e. their acceptance was qualified in relation to matters key to them).
The most contentious area concerns the dividing line separating areas of jurisdiction between adjacent or opposite states where the continental shelf is the natural prolongation of the land territory of both states.
The Convention set out principles on determination of baselines, bays, delimitation between states whose coasts are adjacent or face each other, innocent passage and contiguous zone. It also addressed the notion, limits and regime of the continental shelf. Amongst other things it set out the”equidistance-special circumstances” principle as the method of delimitation of boundaries between states in offshore areas. This provides that the boundary between opposite or adjacent states is to be determined along the median or equidistance line between their respective coasts, in the absence of agreement to the contrary or special circumstances justifying another boundary.
Most importantly, in the North Sea Continental Shelfcase of 1969 the International Court of Justice in the Hague (ICJ), whose decisions are generally regarded as definitive in this area of public international law, declared that there was a body of customary international law on the continental shelf which is identical in content to Articles 1 and 3 of the Convention. It declined to hold that the equidistance principle contained in Article 6 also held the same status, preferring instead “equitable principles”; but in practice the effect of this approach has been to recognize equidistance as a starting point but to emphasise the importance of special circumstances rather than pure equidistance in arriving at final delimitation. Other decisions followed. Most notable was in the Anglo-French Continental Shelf Case(1997-8), which was not a decision of the ICJ but rather of an ad hoc tribunal whose award was published. The case was complicated due to the number and location of islands (especially the Channel Islands, which are close to the French coast), promontories and other irregularities. The tribunal held that “a lateral equidistance line extending…for long distances may…result in inequitable delimitation by reason of the distorting effect of individual geographical features”. In the Libya/Malta Continental Shelfcase of 1985, the ICJ applied an “equitable principles/special circumstances” approach which took into account the general configuration of coastlines and proportionality between length of coastline and length of continental shelf, with the result that it established delimitation 18 minutes north of the equidistance line – in effect recognizing the much greater mass of Libya in comparison with Malta.
In legal historical terms this body of law established by the Convention and ICJ decisions was a remarkable achievement in a relatively short period of time.
The Third United Nations Conference on the Law of the Sea between 1973 and 1982 resulted in an even more wide-ranging Convention on the Law of the Sea of 1982 (“UNCLOS”) which had an even larger number of adherents, but some significant states – most notably the United States – did not adopt it. Nonetheless, in relation to delimitation of boundaries, UNCLOS reaffirmed the principles in the 1958 Convention and the decisions of the ICJ as reflecting customary international law.
The success of this international law regime is well exemplified by the agreement in 2010 of the Russia-Norway treaty on delimitation and cooperation in the Barents Sea and the Arctic Ocean. It was signed after many decades of negotiations going back into the Soviet period.
It remains to be seen how this will play out in the broader reaches of the Arctic Ocean, where both Russia and Canada have very long coastlines and the United States a relatively short one. In recent years, Russian has been carefully taking steps to lay its claim by asserting its position in relative to the Lomonosov and Mendeleev Ridges in its offshore continental shelf area.
Investor-State Dispute Settlement
Having successfully attracted investment, states sometimes – and from an investor’s point of view, far too often - change their minds about the terms that should apply. This has been the experience of many in the petroleum industry over a long period of time. A state trying to attract investment – particularly where no oil or gas has previously been found - may offer an investor very favourable terms which the state (or some key element in it) later regrets. The reasoning before the investor comes in (particularly, but not always, where the population of the state is desperately poor) often is, in effect, that “something is better than nothing” bearing in mind that the state has neither the technical capabilities nor the capital to find petroleum in the ground (whether onshore or offshore) and therefore to do what is necessary to get the interested foreign investors in. It is rarely easy to find oil or gas where none has been found before (even in countries which subsequently prove to have vast and prolific reserves – Iran and Saudi Arabia are a very good examples) so the investor perceives that it is taking very high risks and should be rewarded accordingly. Once the reserves have been proved and developed, all this may be forgotten about, particularly by the government of the state and its population who see “our oil” or “our gas” being produced by foreigners who make a lot of money out of it. Inevitably there are suggestions (or, at least, innuendos) that the clever foreigners with the assistance of their sophisticated international lawyers pulled some sort of “fast one” on the gullible politicians of the state in persuading it to grant the initial terms.
Non-financial aspects may also come into the picture. Environment, health and safety, labour rights and human rights issues can become of great concern and, in some situations, can outweigh the financial side. The imbalance between benefits accruing to the local community and the nation as such can sometimes make the situation very complicated.
This is not only a problem in developing countries – similar situations have arisen in countries as advanced and diverse as the UK and Israel. (The United States, which has had its own powerful domestic industry since the mid-19thcentury, whilst not so much concerned about foreign investment in its petroleum industry, has nonetheless experienced high tensions between the interests of consumers and producers - and massive domestic anti-trust issues - which continue to this day and, in some ways, may be seen by some as analogous.)
Over time, investors from the international petroleum industry have developed techniques for protecting themselves. One of the older techniques was the use of “stabilisation” provisions either in legislation or agreements with governments (or both). Stabilisation provisions can take various forms, the most common of which are clauses which attempt to “freeze” the state’s legislation so that subsequent changes do not affect the investor, clauses which provide that the state will not nationalise the assets or modify the investment contract without the investor’s agreement, economic equilibrium clauses - which provide that the state will maintain the economic equilibrium of the investment and compensate the investor if it is disturbed by e.g. subsequent legislation - and clauses which provide that the burden of changes resulting from subsequent legislation will be borne by the state. Economic equilibrium clauses were particularly common while stabilisation provisions were still fashionable.
The problem with legislative stabilisation is very simple – the state is sovereign, and it is often impossible (particularly in the absence of external pressure from the investor’s home state, which may be reluctant to interfere in another state’s affairs) to prevent the legislation from being changed subsequently. Contractual stabilisation therefore has been preferred, but the drafting of clauses that will be effective in all possible situations is fraught with difficulty, not least because it is often not possible at the outset to anticipate the circumstances that could give rise to a dispute in future. If a dispute arises over a stabilisation clause therefore, however carefully and thoughtfully the draftsman may have worked in preparing it, the claim is almost inevitably a complex, long and hard-fought one.
For this reason, stabilisation clauses have fallen from fashion as a way of providing long term security for investments in the industry.
The industry has tended, in recent years, to focus much more on the form of the grant of rights to exploit petroleum. In Russia, during the Yeltsin years, the international industry was very reluctant to invest under the licencing regime which Russia had adopted to replace that of the Soviet system. Licensing regimes are common in western Europe, so why not in Russia?
The problem with licensing is that it falls under administrative law, under which it is usually much more difficult to bring a claim successfully than under a contract. The industry therefore prefers contractual forms, particularly where the contract provides for a governing law of a state other than the one in which the investment is made (English law being much favoured for this) and international arbitration, which is enforceable under the New York convention. The effectiveness of this was proved in the Libya cases of the 1970s after Libya nationalised the assets of various international oil companies. Although enforcement of awards in Libya itself was not possible, the companies were able to arrest cargoes of oil being exported by Libya and satisfy their claims from the proceeds.
Production sharing agreements (PSAs) in their current form were introduced in Indonesia in the 1960s as a way of giving the state more control and direct participation in petroleum production - in contrast to the more traditional concession agreements which had previously been used in much of the Middle East, Africa, Asia and Latin America. Nonetheless, although the international industry was not happy with the imposition of PSAs at the time, after reflection they took the view that the contractual nature of the relationship under a PSA (particularly if it includes the protections above-indicated) gave them much more protection than under a licence and it became a preferred form of grant of petroleum exploitation rights.
Whereas international companies were willing to live with the uncertainties of licensing in the UK which has a highly respected legal system, they were not willing to take the risk in Russia – at least not until BP struck its highly lucrative deal with TNK, which brought them extensively into the Russian licensing system. The insistence of the other international companies that they would only participate in Russia under PSAs then faded away. PSAs are, nonetheless, still popular with the international industry in other jurisdictions.
In recent years, the industry has also focused on the protections available in Investor-State Dispute Settlement (ISDS). ISDS is another relatively newly developed field. Traditionally, if an investor had a claim against a foreign state and felt it could not obtain an adequate remedy in the state’s own courts or other domestic processes, it could try to prevail upon its own state to take up the claim as between the two states – state-state-dispute-settlement. Some states would conclude Friendship, Commerce and Navigation treaties to facilitate this. However, in practice, because it was necessary to involve the investor’s own state the process was often cumbersome and unsatisfactory both to the investor and the states involved – particularly if the investor’s home state was reluctant to get involved in the dispute.
Since the late 1950s, many states have entered in Bilateral Investment Treaties (BITs). These often provide assurances relating to foreign direct investment such as fair and equitable treatment (which limits arbitrary and discriminatory treatment), protection from expropriation, most favoured nation treatment (nationals and companies of the investor country being treated no worse than those from any other country), national treatment (being treated at least as well as nationals of the investee country), free transfer of investment and returns. The most significant feature of BITs for investors is that they enable the investor to have recourse to international arbitration directly against the host state (without having to ask the investor’s own state to get involved) through international arbitration (so that the investor does not need to go to the domestic courts of the host state).
The development of ISDS has been managed under the auspices of the Investment Center for the Settlement of Investment Disputes based in Washington, D.C. (ICSID). The first BIT was signed in November 1959 between Pakistan and the Federal Republic of Germany. There are now over 2,750 BITs.
There are also multinational treaties – such as the Energy Charter Treaty – and free trade agreements – such as the North American Free Trade Agreement (which is also multinational) and, more recently, Comprehensive Economic and Trade Agreement between Canada and the European Union (CETA)– which include similar protections. CETA includes an unusual dispute settlement by setting up a special court to determine disputes.
An investor initiating an arbitration under a BIT or similar treaty usually has choice of doing so under UNCITRAL rules or ICSID rules.
Each BIT is different. Some states have their own standard forms but, in practice, the actual terms after negotiation may depart from the form and it is necessary to look carefully at the BIT applicable to the situation of the investor concerned. Some investors carefully structure their investments through countries with favourable BITs, but it is essential to check the effectiveness particularly if the structure is somewhat artificial.
Since the late 1990s, there has been an explosion of ISDS claims. This has arisen partly because so many treaties have been signed, partly because of the globalization of business and partly because investors see the example of other investors bringing claims.
ISDS claims are often very high profile. Although the arbitrations are subject to confidentiality, news of an important claim often leaks out or is publicised by one side (or both) and, when this happens, it may become controversial. Governments may complain that ISDS inhibits them from instituting or implementing reforms and policies relating to public health, environmental protection, labour rights and human rights. Against this, it is pointed out that investment treaties do not limit a sovereign’s right to regulate in the public interest in a fair, reasonable and non-discriminatory matter.
The proliferation of cases and their political high profile has resulted in other criticisms particularly since it has become apparent that claims can be directed against developed country states – e.g. under NAFTA or the Energy Charter Treaty – and particularly have emerged in relation to the negotiations between the EU and countries like the US and Canada (hence the different approach to dispute resolution taken in CETA).
It is sometimes suggested that there is a conspiracy between the arbitrators and the law firms to promote ISDS because they earn large fees from it and therefore the arbitrators (many of whom are also practitioners in law firms) tend to favour investors so as to encourage them to being claims. This is particularly the case where arbitrators also practice as counsel. However, according to the International Bar Association (IBA), states have won a higher percentage of ISDS cases than investors and about a third of cases end in settlement. The IBA has also observed that investors, when successful, recover on average less than half of the amounts claimed and that "only 8 per cent of ISDS proceedings are commenced by very large multinational corporations." It also notes that the practice of awarding costs against the losing party also discourages claims with substance.
Another criticism concerns the transparency of the process. Because arbitrations are confidential and conducted in private, the public do not have access and the press particularly can be irked by this. In practice, however, a great deal of information about ISDS cases of public important is, in practice, made public.
Another concern often expressed is that the arbitrators are private practitioners who may or may not have judicial background and that tribunals do not take account of broader policy concerns in that way that judges would. This may be true of some but not all, and, generally, the arbitrators involved in ISDS cases tend to be highly qualified.
There is also the advantage in most ISDS arbitrations that the tribunal consists of three arbitrators, with each party appointing one and the third determined either by the parties or their appointees or, if they can’t agree, by an institution agreed on by the parties. The parties therefore have greater control over the selection of arbitrators than is usual in court proceedings, although this point is often ignored in the debate over the merits of ISDS.
One approach is for the BIT or trade agreement to provide for the establishment of an “investor court” to provide greater accountability and transparency. This was the approach taken in CETA, which has recently been approved by the European Court of Justice as compliant with EU law.
By Doran Doeh,
36 Stone, Arbitrator, London