The Realities of Stabilization Clauses in Petroleum Investment Contracts (1)

With the pending passage of the Petroleum Industry Bill (PIB), the issue of policy reversal proposition that may affect the terms of previous petroleum investment agreements becomes imperative. Frequently, investors in the petroleum sector seek guarantees, contractual or otherwise to protect their investment – through stabilization clauses.

Generally, a stabilization clause is a contractual drafting technique used to mitigate political risks in a host country. Foreign investors in the oil and gas industry see the difference in socio-economic, ideological outlook and legal framework of host governments as a potential risk impeding investment in emerging economies.

Oftentimes, private investors have to bear the risk that their expectation may be frustrated by the host government in course of time in the usually long duration of such agreements. changes, which are either change in government or fiscal regimes, are considered burdensome to an international oil company. They often lead to additional obligations – decreased investments and expected future revenues.

The use of stabilization clause was said to have originated in the period between World War I and World War II when US companies used it to preserve concession agreements – because of Latin American nationalizations of foreign oil and gas companies. Its usage has been universally accepted in international energy investment contracts, as a security to inhibit legislative or administrative override to mutually accepted contractual terms.

Stability clauses can be classified under two categories, namely: freezing clauses – preserves the contract and/or fiscal terms for a certain period of time, and equilibrium clauses – that allow for an adjustment of the contractual terms over time so that a change in circumstances does not damage or benefit one party to the advantage or detriment of the other.

Take for example, a Nigerian Production Sharing Contract (PSC) with an equilibrium stability clause which provides that: “The Parties agree that the commercial terms and conditions of this contract are based on the existing fiscal terms in accordance with the provisions of the Deep Offshore and Inland Basin Production Sharing Contract Act, 1999, if such fiscal terms are changed, the Parties agree, subject to Clause 27.3, to review the terms and conditions of this Contract affected by such changes to align such terms and conditions with the fiscal terms.”

Parties may include stability provisions in the contract to insulate the contractual relationship from any governmental legislative or administrative measures that may have the effect of annulling or altering such relationships. The stability clause is believed to maintain contract terms, notably the fiscal regime which may later be argued as defective by the receiving party – usually host governments.

In industries with long time cycles and substantial advance investments, stable and predictable contractual and fiscal terms are very important considerations in ranking investment opportunities, with obvious effects on a country’s future prospects. This is probably true for the hydrocarbon industry, in which long project cycles are coupled with great uncertainty with regard to resource prices and project output. The stability of the fiscal regime also impacts business assurances and affects the level of investment in and pace of development of existing projects.

It is indisputable that a host country has the sovereign right over natural resources that exist within its territory that allows it to issue new laws and regulations in order to cover its socio-economic needs. Exercising this sovereign right may negatively affect petroleum investors in their contractual relations with the host country.                                            felix.ayanruohlaw@gmail.com

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Artice title: The Realities of Stabilization Clauses in Petroleum Investment Contracts (1)



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