Thursday, June 7, 2012

The Efficacy of Stabilization Clause

By Tarek Ghaleb

Stabilization clause is a contractual tool, whose purpose is to mitigate political risks in a host country. One of the main aims for the International oil and gas companies when it establishes an investment in a foreign country is to minimize the political risks in the foreign country during the life-term of international petroleum investment contracts, in such a manner that no changes or agreed changes with flexibility will occur in the agreement in the future after the date of signature of the agreement. These changes, which are considered as a nightmare for an international oil and gas company, may lead to additional obligations for this company or deprivation of its investments and expected future revenues from investments. The stabilization clause limits regulatory power of the host country in the fields stipulated in the clause. 

The host country has the sovereignty right over natural resources that exist within its territory that allow it to issue new laws and regulations in order to cover its social and economical needs. Exercising this sovereignty right may affect negatively the petroleum investors in the contractual relations between the host country and the investors. Including the stabilization clause to these petroleum agreements limit this sovereign power of the host country. The aim of the research is to examine the efficiency of the stabilization provisions in petroleum agreements, illustrating the mechanism how these provisions works, their factions, and addressing the issues of legal and practical effects of the stabilization clause. Moreover the paper investigates the issue of compensation as consequences of breaching the clause. 
Majority of oil and gas producing countries are developing countries. In these countries the oil and gas industry is considered as a vital source of development of country’s economy. Some countries have petroleum reserves, but do not have funds to finance own oil and gas projects. In order to make up this deficiency, these host countries (hereinafter – ‘HC’) invite foreign investors, which are International Oil and Gas Companies (hereinafter – ‘IOC’). HC endeavor to create investment friendly environment in their countries, offering special contractual provisions that IOCs prefer to have in their petroleum contract in order to minimize risks that IOCs may face, investing large capital in petroleum industry during long period of time. There are different kinds of risks: commercial, geological and political. One of these risks is the political risks which is the stabilization clause is concerned with. Therefore, the IOC may require a protection from the political risk which can lead for the nationalization of its property by adopting the stabilization clause in the International Petroleum Agreement (hereinafter – ‘IPA’). 

The stabilization clause provides the IOC protection in which it will reduce the political risk which can affect the IPA. The stabilization clause guarantees the foreign investor the protection from any unilateral actions and the expropriation which the HC may exercise. Thus these facts address the following question that can be considered as the research question of this paper: does the stabilization clause really help IOCs to mitigate political risks? 

The Concept of Stabilization Clause. 

Definition of stabilization clause: 
The stabilization clause in the IPA can be defined as “a mechanism, contractual or otherwise, which aims to preserve over the life of the contact the benefit of specific economic and legal conditions which the parties considered to be appropriate at the time they entered in to the contract”. From this definition we can conclude that the role of the stabilization clause is to provide a guaranty and security to the parties of IPA that the obligations with respect to the investment under the agreement cannot be the subject of changes after signing of this agreement and during its whole duration. The idea of the stabilization clause is to prevent that the HC will add any additional obligations after the effecting date of the agreement on the investor – IOC, the reason is that these changes in the obligations may lead on changing of legitimate expectations which was agreed between the parties within the agreement[1]

 The function of stabilization clause in the IPA is to avoid any political risks, which may occur due to unilateral actions of HC as exercising its sovereignty rights, for example, in changing the legislation.[2] Adding the stabilization clause, the investor is given guaranties that the IPA, which it signs with HC, cannot be the subject to amendments that supposed to be made due to any changes in the legislation or administration measurements, introduced after the singing date of the IPA. The term stabilization comes from the word ‘stability’, which means that the relations between the parties to the IPA under applicable law remain stable as for a certain date[3]. The stabilization clause may assure that the investment will not face the factors that can affect negatively on petroleum project as the subject of IPA or the termination of IPA by HC before the termination date.[4]

Thus the main goal of the stabilization clause is to provide investor with the investments protection. The protection, which the stabilization clauses can provide, is not regarding any commercial risks (for example, price fluctuation), but regarding non-commercial risks, such a modifying the fiscal regime or adding more obligations under HC’s new decrees and laws, which are considered as political risks[5]. This protection can be against all or particular unilateral changes to the agreement, which are exercised usually by HC for the reasons that IPA is considered as not fair enough, made in favor of IOC or that the HC wants to gain more control over the activity, investments and/or assets of IOC. Moreover stabilization clause may provide investor with protection against expropriatory actions of HC. The protection role, which the stabilization clause plays, creates a stable environment for the investors in order to encourage them to invest, especially in those countries, which are considered as unstable politically.[6]

The stabilization clauses are found in the concession agreements. The purpose of adding the stabilization clause in the concession agreement is to provide a security for the investor within the frameworks of the concession itself. It is made in order the change of HC’s governments or domestic laws not to make any impact to IOC or not to increase its obligations under the concession. The stabilization clauses in oil and gas concession have to freeze the applicable laws to this concession at the date of signature of the concession agreement or to create a degree of flexibility. Thus, having stabilization provisions in the concession, any changes in the government or in the domestic laws of the HC as an applicable law do not affect on investor or the concession.[7]

For example, the stabilization clause in the concession agreement between Libyan American Oil Company (LIAMCO) and Libya Arab Republic stipulates the following: 

 “1 - The Government of Libya, commission and the appropriate provincial authorities my take all the steps necessary to ensure that the Company enjoys all the rights conferred by this Concession. The contractual rights expressly created by this concession shall not be altered except by mutual consent of the parties. 

2 - This Concession shall throughout the period of its validity be construed in accordance with petroleum laws and the regulations in force on the date of execution of the Agreement of amendment by which this paragraph 2 was incorporated into the Concession agreement. Any amendments to or repeal of such regulation shall not affect the contractual rights of the company without its consent”.[8]

In order to make the stabilization clause effective and valid, the clause should be expressed in oil and gas agreement itself, which can be a concession or IPA, which is recognized by the HC, by signing the clause, and considered as a part in the agreement. In addition to that there should not be any conflict between the stabilization clause and the domestic laws of HC, in order to prevent any doubts about the validity of the clause[9]. Moreover, the government of HC is not the only entity, which is entitled to enter an agreement, which include the stabilization clause. Also the National Oil and Gas Company (hereinafter – ‘NOC’) is entitle to enter agreement with foreigner investors, containing the stabilization clause, but in order the NOC to be able to enter these agreements it has to have a necessary authority, granted by the government, law of HC, hereby decreasing the possibility that the stabilization clause may be recognized as null and invalid.[10] This point of view is supported by EL-Kosheri and Raid: “The legality of the stabilization clause can only be established on the basis of a public law rule which authorizes the contracting governmental party to include such clauses in development and to be bound thereby”[11]

For example, petroleum agreement with stabilization clause, signed between IOC and Algerian NOC: 

“In the event of changes in the Algerian laws made after this Contact is signed, which result in a substantial reduction of the rights or increase in the obligations of one or the other Party, Sonatrah (the NCO) and the Partner (the investor) will negotiate amendments to re-establish the same rights as those agreed on the date the contact was signed”.[12]

This analysis by Tareq on Stabilization Clause is divided into several parts for ease of understanding. First he defines the concept of the stabilization in order to bring the reader up to speed with the foundation of his analysis. In the next installment he will illustrate its functions and types (Stabilization Clause) and discuss in details the political risks that can be mitigated under stabilization provisions, examine the legal effect of stabilization clause under domestic laws as well as under international laws, using doctrinal approach. Corporate Investment is key for development of natural resources however the extent to which companies are aware of and secure their interests is quite important. Company Lawyers and Key Decision Makers will find that this sort of analysis will help to shape corporate decision making in contracting with host countries- for the best possible outcomes. For more information on this article and to view Tareq's professional profile, click here -->. 

[1]  P, Cameron (2010). International Energy Investment Law. United state: Oxford University Press. 68-69.
[2] M, Erkan(2011). International Energy Investment law : Stability through Contractual Clauses . Netherlands : kluwer Law International. 101.
[3]  T , Begic (2005). Applicable Law In International Investment Disputes. Netherlands : Eleven International. 84.
[4]  M, Sornarajah (2004). The International Law on Foreign Investment ( 2nd ed. Cambridge UK: cambridge Uneversity Press). 407.

[5]Coale, M. (2002). Stabilization clauses in international petroleum transactions. Available:;col1. Last accessed 23th Feb 2011. Pg 1
[6]C,Duval. H, Le Leuch. A, Pertuzio. and J, Weaver (2009). International Petroleum Exploration And Exploitation Agreements. 2nd ed. United State: Barrows Company INC. 340-341.
[7] R, Bishop. J, Crawford and W, Reisman (2005). Foreign investment disputes: cases, materials, and commentary. Netherlands: kluwer Law International. 293.
[8] Libyan American Oil Company (Liamco) v. Libyan Arab Republic, 20 ILM 1
[9] Supra Note 2. Pg 108 .
[10] Ibid Pg 109.
[11] Ibid
[12] Supra Note 1. Pg 80.

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