The Journal of World Energy Law & Business

The Journal of World Energy Law & Business 2008 1(1):55-97; doi:10.1093/jwelb/jwn005

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© The Author 2008. Published by Oxford University Press on behalf of the AIPN. All rights reserved.

Renegotiating acquired rights in the oil and gas industries: Industry and political cycles meet the rule of law

Thomas W. Wälde^*

^* Dr. iur (Frankfurt), LLM. (Harvard), Professor and Jean-Monnet Chair, CEPMLP, University of Dundee; Rechtsanwalt (Frankfurt) and barrister (Essex Court Chambers/Lincoln’s Inn (London)).

	1. The issue: Do the instruments of good governance and the rule of law have any significance when faced with the force of the energy and resource industries cycles?

Top 1. The issue: Do... 2. Context of current... 3. What does this... 4. Types and dynamics... 5. Rights, rules and... 6. The 'rule of... 7. International protection of... 8. Conclusion Notes

 
As we experience a so far sustained upwards trend in the price of petroleum and minerals,¹ governments of producing countries worldwide are engaged in a fundamental revision of the terms under which international investors originally carried out their investment.² Changes are most extensive in the cases where contracts with host states (or their state enterprises) were negotiated in times of relatively low oil, gas and mineral prices (in particular between 1985 and 1999); in the cases where a fundamental re-orientation of a host state’s policy towards foreign and private investment has taken place (eg in countries where governments now pursue a policy of anti-Western (in particular anti-USA) resource nationalism); and in the cases where new governments have reversed visibly and significantly the policies of privatization of state-owned operated upstream oil and gas and mining assets carried out in the 1990s. The renegotiation demands are more acute where the original contracts did not provide for a balanced internal adaptation system providing, now, a politically acceptable outcome for the host state. Even an internal adjustment system which responds to changes in profitability and mineral rent (eg with rate-of-return-based financial regimes) may not be able to fully accommodate host state revision demands if its structure reflects unequal bargaining power at the time of negotiation. Contracts concluded with quite inexperienced governments, for example newly independent petroleum states that emerged after the collapse of the Soviet Union have come under pressure, in particular if the explosion in oil prices has not led to a corresponding (and politically visible) increase in government income.³ This is particularly so if production in the early years has not been producing substantial government income; in such cases, it looks as if the resource is extracted and given away for free.⁴ This is politically not acceptable and least in an unexpected high-price environment.

The current high point in the resource price cycle facilitates and enables policies of resource nationalism and re-orientation from private ownership to state control which were largely at bay during the low points of the price cycle (mainly from the late 1980s to approximately 2000). Resource nationalism has raised its head again. Political demands, often dressed in legal concepts, that were last heard of in the ‘NIEO’ (New International Economic Order) period of the 1970s,⁵ are now again the common currency of resource nationalism. These include arguments that contracts are only valid rebus sic stantibus (ie as long as circumstances remain the same), that governments have a unilateral ‘sovereign’ right to revoke or substantially modify contractual terms and that the rights of investors acquired since the 1980s under the international investment protection treaties are now subject to the overriding jurisdiction of national courts.⁶ In essence, such views posit that acquired rights are subject to the discretion of governments which is not much different from saying these are mere ‘political understandings’ devoid of a truly legally binding character. The implication of the view of absolute state sovereignty over such ‘state contracts’⁷ means, in functional and effect terms, that agreements with host states, in particular those with de-facto state control over their national judiciaries, are essentially a temporary political understanding. This would be less problematic if there was a continuous reciprocal exchange. But foreign investment involves an initial capital investment which is only recovered over long periods of time. The host state controls, via regulatory and tax powers, such recovery and the investor is thus exposed as ‘hostage’ to host state powers. The whole of international investment law, in particular theories of internationalization of applicable law, stabilization clauses, access to international arbitration and most recently and most powerfully investment treaties with direct investor–state arbitration, can be understood as trying to remedy such unilateral exposure of the investor to host state powers after the investment has been made and the ‘hostage’ effect triggered (both now available on OGEL (Oil, Gas and Energy Law Intelligence) & TDM (Translational Dispute Management)). Bringing the ‘rule of law’ to such arrangements means to transform them from political understandings subject to the discretion of the host state⁸ to contractual promises that can be made effective under a legal system and enforcement procedure outside host state control and therefore credible and more suitable to be the basis for large-scale, initial capital investment.⁹

This paper discusses the role of ‘law’ as it faces the political pressures of resource nationalism supported and financially enabled by the sustained high prices. It questions whether the concept of the ‘rule of law’ (originated in the Western history and embedded in its political and social culture)¹⁰ has any material meaning in the investor–resource state relationship. This concept of the ‘rule of law’ with respect to individual rights against the state is embodied in contracts between the foreign investor with the host state or with its state enterprises, in specific stabilization agreements and stabilization clauses, in guarantees provided in national investment or petroleum/mineral legislation and internationalized by submission to international arbitration. The notion of the ‘rule of law’ also underlies modern treaty-based investment protection practice, which was substantially created during the late 1980s in widespread bilateral and multilateral investment treaties, such as the over 2500 bilateral investment treaties (BITs), the North-American Free Trade Agreement (NAFTA) or the Energy Charter Treaty (ECT) of 1994 that includes 50 plus countries. While one can discuss the different views on the principle of ‘rule of law’, at the core of the principle are the notions that legal rules should be predictable and that acquired rights should be (within parameters set by law) respected.¹¹

One needs to bear in mind that not every change in the significant terms of a long-term resource investment for an investor imposed by government power amounts to something that could be qualified as a breach of the rule of law. If all or specific terms (eg in particular tax) have been contractually specified, without an opening to evolving regulation, then a unilateral change by the government at least suggests a presumption of breach of the relevant contract. This is even more so if a specific traditionally styled stabilization clause¹² prohibits the application of such changes to a protected foreign investor. Some regulatory and fiscal changes may also, under international investment law, contravene a currently debated ‘obligation’ of the host state to maintain the essential stability of the investment conditions, in particular if the investor can rely here on the concept of ‘legitimate expectations’¹³ as part of the obligation to provide ‘fair and equitable treatment’ even if there is no specific governmental assurance. But regulatory and fiscal changes in areas not covered and constrained by either a contract or an international law obligation (which may reinforce a national law rule later reversed) are not a breach of law. Most developed producing countries – including the UK,¹⁴ the USA or Norway – adjust their tax and regulatory system regularly. Normally, such adjustments take into account the relative profitability of the industry (and thus the size of the ‘resource rent’ available for taxation¹⁵) which is normally quite responsive to the price levels. But other factors matter, such as the perceived need to encourage investment in high-risk and high-cost exploration (eg North Sea) or in contrast, conservation policies aimed at long-term sustainability of the industry as well as evolving practices, standards and political expectations with respect to local benefits, safety or the environment. In such cases, companies tend to invest with an expectation that the fiscal and regulatory regime will be adjusted ‘reasonably and without too much surprise or predatory exploitation of tax opportunities. Investors balance the political, fiscal and regulatory risk with the expected benefit. In such contexts of ‘rule of law’ and reasonable, consultation-based regulation and taxation specific stabilization instruments are rarely negotiated, relied upon or invoked in arbitration or litigation. Arbitration is less important to investors than it would be in situations of high political risk and politically controlled domestic courts.¹⁶

Legal instruments for investment protection will be deployed, relied upon and invoked in situations where the political risk is seen as high and where such instruments are available in order to mitigate the political risk perception and thus change the risk–reward balance to encourage investment. Where the risk is seen as low (ie generally in developed countries), mechanisms to manage it (stabilization clauses, international arbitration and investment protection treaties) are less frequent, less relevant and rarely invoked. Investment protection instruments are most relied upon where they are seen as useful.¹⁷ In situations where there is a high political risk and no sufficiently credible investment protection available through the domestic judiciary (eg at present in a pronounced way in Russia, Venezuela or Bolivia), investors have to make their investment decision on the basis of an unmitigated risk–reward balancing dependent on price, cost and profitability forecasting. They will also be pushed to seek recourse in non-legal ways of protecting their investment by linking themselves with powerful domestic powers through granting in effect free equity as the price to be paid for political protection, reliance on home state support and other ways of informal and political management of disputes (largely by corruption). These non-legal ways have a high price; normally much higher than in a situation where legal methods of investment protection in a rule of law context can be effective. They are also often not available to large Western companies subject to anti-bribery regulation and NGO scrutiny.

To what extent does the arsenal of risk management tools (eg international commercial and investment arbitration, contract with the state, stabilization clauses and contractual adaptation mechanism) actually work under the pressure of the upwards part of the resource cycle? After each period of resource nationalism, usually associated with an upward cycle, new legal instruments have been designed to cope with the way the political risks materialized in the last cycle. The current tool box of risk management instruments¹⁸ developed as a response to the widespread nationalizations and coercive renegotiations of the ‘NIEO’ period in the 1970s and third world rhetoric about the ‘New International Economic Order’. As the recent Stanford General Counsels group concluded, these more modern political risk management tools have not been able to prevent a widespread breach of contracts in economic emergency situations (Asia 1998 and thereafter; Argentina 2002 and thereafter).¹⁹ Nor have they been able to provide full protection to international oil companies in countries such as Russia, Venezuela or Bolivia where reliance on investment protection instruments would have meant a forced, uncompensated exit from the country. There would have been a swap of assets governed by new and significantly deteriorated fiscal, regulatory and ownership regimes against litigation claims, ie the prospects of protracted international arbitral litigation with no assurance of payment in case of an award for the investor claimant. This overall statement should not be interpreted to mean that the new, three-tier-based investment protection methodology (national law, contractual mechanisms, international arbitration and treaty-based arbitration) does not provide protection at all. It simply suggests that it does not provide the full and comprehensive protection for which it was designed for and which some optimists expected.

A ‘legal sceptic’ (normally specialists from economics, political sciences and international lawyers in a strongly ‘realist’ tradition)²⁰ would suggest that the law – what lawyers do, say, formulate and structure – is a mere form and has no substantive effect in controlling or influencing the forces of the resource industries, including the politics of host states and the political economy in which the industries operate.²¹ They would suggest that the written rules – in national law, contracts, international treaties and customary international law from jurisprudence by courts and tribunals – are simply an illusion of security. They serve as a comfort blanket and tranquillizer for corporate management, investors, banks and financial markets. They allow them to accept high-risk investments under the fiction that the law will protect the terms of such investment and thus the risk–reward balance underlying the original investment decision. Legal sceptics suggest that contracts and proprietary rights are nothing but pious ‘declarations of intent’ and ‘political statements’. They are meant to provide false, but willingly accepted, assurances to the many participants. But in the end, they are fully exposed to the vagaries of the host state political process and to the political relations of host and home states. The law, in this view, is nothing more than an illusion that is a necessary fiction for operations in a highly politicized market. Developing (or transition) petro-states do not operate under the ‘rule of law’. They rather use – in President Putin’s word²² – a ‘dictatorship of law’, ie they use the law with selective enforcement to ensure no legal right can be safely acquired and all rights are exposed to the power of those who control the formal and informal levers of power.²³ In such countries there is no ‘rule of law’ except in formal terms. Rather, there is a ‘rule by law’ as those in power impose the appearance of operating in alignment with the formalities of the law. But in reality, the formalities and the institutions of the law (eg, courts, prosecutors, judicial system, police, tax authorities, etc²⁴) are under the full and direct control of those with political power over the machinery of the state.

Quite apart from the philosophical differences about the true role of law in the international energy investment, there is also a wider question as to whether it is truly possible to fix the originally negotiated and desired terms for a long-term relationship – by contract, by national law desirous to attract investment or by international treaty. Is the future simply unmanageable and a matter of uncertain fate, or can lawyers with their ever-increasing sophistication and complexity of very detailed and indepth ‘documentation’ really freeze the present and fix the future – like playing God? Or is much of the legal work on such transactions rather a game of creating illusions that satisfy shareholders, financiers, regulators and capital market; but in reality has only a moderate effect. And the less so, the more distant the future and the greater the chasm in geography, political ideology, religion and culture, all exacerbated by the volatilities of the economic and political cycles overshadowing international energy investment?

	2. Context of current energy and resource investment disputes

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The context of current disputes (in particular in the field of oil, gas and minerals) is in the upwards (and unusually high) phase of the price cycle in the petroleum and mining industries.²⁵ Similar disputes have been occurring in the energy and infrastructure industries (electricity; water; telecommunications and roads).²⁶ Such disputes are not directly linked to the upwards cycle in oil, gas and minerals but probably to the ‘political cycle’ of attitudes towards foreign investment with a reaction towards the privatization policies of the 1990s. In those countries with significant petroleum or mining production, re-nationalization, coercive renegotiation or regulatory and fiscal squeezes on post-privatization foreign investors should be viewed as politically supported and financially enabled by the large mineral rents available to the government.²⁷

Investment disputes involve a fundamental change of government and political philosophy. A predecessor government did the deal – its successor wants to undo it. It will not be easy to find a case where a dispute arises between the government in place at the time of investment and the investor. Such unusual cases might arise out of a change of senior government personnel, a breakdown of personal relationships, unsuccessful, selective or refused corruption or a serious change in the external circumstances of an investment. The ‘normal’ situation of an investment dispute is that the terms legislated or agreed upon and stabilized in one form or other (by the way of law, contractual stabilization clause or a treaty-based stabilization²⁸) are no longer supported and respected by a subsequent government. International law (nor most national laws) does not recognize a change of government as a reason to invalidate contractual and similar commitments made by a prior government. The idea is that the government has legitimate powers of agency that bind the ‘state’ irrespective of who the government of the day is.²⁹

Nevertheless in practice, contractually or otherwise legally fixed investment terms tend to become shaky if a new government takes power. Existing supporters and friends have vacated office and power for adversaries; except if such friendship (often politically inevitable) is deftly managed and can be transferred to those newly in power, the foreign investor will bear the political cost of proximity to the former government. The risk of regime change for established investors is particularly acute if the new government pursues a fundamentally different policy towards private and foreign investment in resources seen as strategic; eg oil, gas, energy, mining, infrastructure and telecommunications.³⁰ The Venezuelan ‘apertura’ pre-Chávez thus leads to very large oil, gas and mineral investment; most of which has been taken over or seriously renegotiated by late 2007.³¹ If the new government intends to fundamentally reverse its predecessor’s policies on issues such as investment promotion and privatization (such as Venezuela, Ecuador and Bolivia recently), then the contracts entered into and investments made under the promotional policies and terms of the prior government naturally become the target of the new government. This is nothing new. The first Garcia government in Peru reversed its predecessor government’s investment promotion policies by coercive renegotiation (with Occidental Petroleum) and nationalization (of BELCO petroleum) in 1985. Once in power, a new government will feel compelled by its own opposition rhetoric and campaigning history to do something and even more so, to be seen doing something about the much criticized friendly relations of its predecessor with foreign investors. This political dynamic of government succession leads to a review of contracts and regulatory and fiscal terms. The result of such a review can be a cosmetic revision of such terms for public consumption or it can lead to formal investment disputes. The latter is the case when either the new government does not have the willpower or political capital to agree to a reasonable settlement with the foreign investor or when the investor does not have the political skill to negotiate arrangements that both accommodate its own vital interests and also provide visible negotiating success to the new government. Part of the skill in negotiating host state–investor arrangements was to provide to the investor what it required (management control over risk capital invested) while providing to the government the outward appearances of sovereignty and power. One can view the now prevailing production-sharing contract as a legal instrument that satisfies both essential needs of investor and government. Its amazing success is largely due to the fact that it is a supple and subtle instrument that can satisfy both the substance of the investor’s hard-core requirements and the appearance of mastery and control that governments need.³²

These political pressures against the foreign investor arising out of a change of government (be it minor or substantial) are exacerbated by the suitability of the ‘foreign’ investor to become the target of host state politics. No country, society or culture exists in the world where there is not suspicion of foreigners. This is simply human (and in fact animal) nature. The forces that pull humans together to create communities are the same that create a distinction between ‘we’ and ‘them’. Resentment against the foreigner (which can be at times a distinct national ethnic minority)³³ is therefore not only natural and a constant challenge for foreign investment, but it is also a continuously reshaped weapon in the domestic political struggle. Accusing the government of favoritism towards foreign investors, with notes of disloyalty and treason to the nation,³⁴ is thus a standard theme in opposition politics. The charge works best against governments which were compelled, in the downwards part of the resource cycle and in national economic depression, to pursue an investment promotion policy. It is also likely to have a particularly strong effect in societies undermined by powerful ethnic and class divisions where the upper classes have a colonial or immigration background and are educationally and culturally oriented towards Western states – as is the case for most of Latin America. The weakness of internal social cohesion leads to a particular emphasis on nationalism³⁵ and its necessary companion: suspicion bordering on paranoia towards the foreign investor. This is never more so if the foreign investor is extracting non-renewable ‘national’ resources to sell abroad.³⁶

It is therefore not remarkable that a change of government leads to action against foreign investors even if it is not in the interest of the state to increase its political risk by greater volatility of economic policies and periodic rejection of foreign investment. Greater ‘maturity’ in terms of a diversified economy without dependency on oil or mineral commodities and an orderly transition between governments will reduce that risk. However even in mature, diverse economies there is an occasional witch hunt against foreign businesses as the history of foreign corporate take-overs in both the EU and USA demonstrates.³⁷ The absence of an effective rule of law, anchored socially, institutionally and culturally, intensifies the political cycle and undermines the potential to create a more effective rule of law that respects acquired rights and provides a reasonable governance system.

This deeply seated suspicion and resentment of ‘foreign’ investors does not necessarily extend to ‘domestic’ investors. Domestic investors may behave similarly to foreign investors or worse, as they are often much less subject to international and home state focus, NGO campaigning, monitoring, standards and guidelines. They are, however, much more immune from the suspicion directed towards the foreigner; they also benefit from deep roots and networks in the domestic political system. Modern (Western) international companies have much less scope for bribery and developing deep links with host state politicians and civil servants than they may have had in the past, due to the international anti-bribery laws and the constant scrutiny from NGOs³⁸ and financial markets. This does not apply to national entrepreneurs. Their prosperity will have been inextricably linked to those in power. The Russian oligarchs are the best-known case.³⁹ Here, the continued existence and effectiveness of property rights is conditioned on good will with the government and those who dominate it. A number of publicized investment disputes have highlighted the affiliation between domestic politicians and senior civil servants with domestic entrepreneurs in competition with international investors.⁴⁰ Competition of international investors with powerful domestic (public or private) commercial interests will therefore often end in the defeat of the foreign investor, eg the recent forced transfer of majority ownership by Shell, EXXON and BP to Gazprom.⁴¹

At times the foreign investor will not be penalized because of their ‘outsider’ status, but because they have been associated (or were forced by law of ‘political economy’ of local business to associate) with domestic powers. Foreign investment in energy, resources and infrastructure by its very nature requires intensive interaction with government and domestic politics. It is hard to carry out such investments without having to make friends with those who hold power. When such power fails, deals made with former authority figures are inevitably questioned and the investor loses the political and governmental support they need. Except if the investor is deft and lucky enough to engineer a change of tack and build synergistic relationships with those newly in power. This requires both an anticipation that current power relationships may not be forever and a degree of duplicitousness in nurturing a back-channel with the opposition and political alertness in terms of restructuring political patronage when power changes; this strategy does not come easily to large international corporate bureaucracies.

Such dynamics of investment disputes are aggravated as the resource industries’ cycle progresses. Resource industries, in particular oil and metals, move in cycles.⁴² These may not operate in a simple and predictable fashion. They are influenced by other factors such as wars, financial crises and producing countries’ coordination (OPEC). However, the basic economic logic is that increases in demand lead over time to higher prices and then higher investment and higher production. Higher production over time leads to oversupply; oversupply to lower prices, reduced investment and shrinking of supply. On the demand side, higher prices lead ultimately to a lowering of demand (including greater resource use efficiency and substitution) while low prices will tend to encourage demand and slow down application of new technologies to reduce energy intensity.

The adaptation of supply and demand to prices tends to be unusually slow in the resource industries. This is perhaps the specific feature of the general demand–supply rule in the field of petroleum and mining. Demand is not very flexible and leads only to some adjustment with a considerable lag of time. The same applies for supply. It takes several years, often more than a decade, for new investment to be undertaken through exploration, development and start-up of production. New investment is based on – notoriously unreliable – forecast of prices, usually based on some averaging out. Existing facilities will continue to produce even if at a loss, so long as operating (minus mothballing) cost is covered by revenues, thus prolonging an excess of production and aggravating the downward trend. Operating costs are in these industries comparatively modest in comparison to the very high capital cost of oil, gas and mining facilities. The special characteristics of the resource industries tend to intensify and prolong both the upward and the downward price cycles. The politicized, regulated and governmentally influenced nature of the resource industries adds to the specific characteristics of the petroleum and metals’ markets. In oil, the key producers in OPEC try, often successfully, to bring about a concerted policy of production control thus lifting or maintaining prices when the market fundamentals would suggest otherwise.⁴³ This leads to another element: the slowing down of market-based signals. Furthermore, the most important OPEC countries in the Middle East, in particular Saudi Arabia and to a lesser extent the Gulf states, have excluded or seriously diminished the role of international oil companies in upstream oil and gas investment. This means that high prices do not exercise the same effect of encouraging production from existing facilities as they would in a primarily market-based system. The now dominant OPEC country state enterprises (Saudi ARAMCO (Arabian Oil Co); NIOC (The National Iranian Oil Company); Sonatrach, et al) and also Norwegian (Statoil), Mexican (Pemex) or Russian (Gazprom and Rosneft) companies do not obey market logic as private oil companies do. They instead invest under tight control of the countries’ budget authorities and have to take into account the state’s availability of or need for finance and the states’ conservation policies. In particular, the oil market (not yet the gas market and much less so the metals’ market) is thus a mixture of market-based and political logic, perhaps reminiscent of the structure of command–control ‘war’ economies with elements of market features. With a high oil price and large government revenues, there is little reason to increase production (assuming there was unused capacity) or to encourage investment. If investment in replacement capacity is desired, the capital is easily available, with little need for the capital contribution by international oil companies; these, anyway, are now in intense competition for acreage with the state oil companies from China and India which are flushed with money and thus able to pay well, to be more accommodating than private companies to more restrictive terms and pursuing a political mandate to increase energy flows to their home countries.⁴⁴

	3. What does this mean for the dynamics of investment disputes?

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Let us look first at the ‘bottom’ of the resource cycle. At this stage, the host state, typically dependent on mineral production and export, will earn little revenue as the difference between cost and price will be minimal. Royalty (ie percentage of sales’ price)-based tax regimes will make continuation of production even more prohibitive so that both a reduction of production and mineral rent seriously diminish government income. There is no case for investment by state companies as any revenues that are generated will be required to sustain the government services built up in a time of high prices. The decline of such revenues will not only restrict any state enterprise investment, but will also lead to a serious stress on the political legitimacy of the government depending on the ability to finance political patronage and social services built up in a time of plenty.⁴⁵ The only sensible policy at this time is to encourage private investment by international companies and to privatize loss-making state enterprises, often coupled with financial and social austerity programs including a reduction of government expenditures and taxes. Host state bargaining power is at the low point. Investors ready to invest at the bottom of the resource cycle (ie when all the predictions about the future are dire) will have considerable leverage. Investment promotion means a lowering of tax and of other regulatory burdens combined guarantee that such terms will last. Such guarantees will have to be credible as the past record of most host states suggests that favorable terms will not last. Intensive efforts are therefore expended on constructing credible guarantees, through national law, investment agreements, stabilization clauses and accession to investment protection treaties that are enforced by international adjudication.⁴⁶

As the resource industries’ cycle gradually – and with considerable time lag – moves upwards, the situation changes. No longer are investment incentives necessary. In the upward phase, governments have extensive liquidity. They have repaid their debt. There are ample resources available from now exploding ‘mineral rent’ to finance social and political services and patronage to sustain them in power. They no longer need to expand production and can afford the luxury of thinking about conservation of resources for the future. There is no inherent limitation on the ability of state enterprises to invest and ample capital is available to nationalize – either by purchase, by decree or by coercive purchase under threat of nationalization by decree. Technology – services, equipment and project management – can be purchased from service companies.⁴⁷ The ‘slimming’ of oil companies in the late 1980s and early 1990s has fostered a large number of service contractors able to provide the needed technological and management services to state oil companies; earlier, these services were located inhouse in major private oil companies and thus not easily available to the state oil companies. International oil companies are desperate not to lose access to reserves and are thus willing to enter into high-priced deals to acquire new acreage or to consent to host government demands to renegotiate the deals, now seen as too favorable, entered into at the low point of the resources’ cycle. They compete with cash-rich enterprises from China and India politically mandated to acquire at whatever cost security of supply in producing countries. The industry cycle reinforces the political cycle. Governments that have salvaged economies in depression with austerity, investment promotion and privatization policies⁴⁸ are now accused of having yielded to blandishment and bribery by international investors. Their policies are discredited and painted as having been executed by governments in the pay of the suspected ‘foreignerx’ under suspicious ideological concepts such as capitalism and neo-liberalism. The outcome is either a simple yielding by international companies, anxious to prevent a complete write-off of their investments (now having a higher value due to higher prices and thus more able to cope with higher taxes and government takes) or, if there is no net benefit of maintaining the investment under revised terms, an exit accompanied by using available legal procedures for asserting the legal validity of rights acquired in the earlier phases of the cycle.

Even when the high point of the cycle is reached, there is no stand-still. The nature of the cycle is the movement of the wheel. The high point carries the seed for the now declining movement of the wheel. When the cycle is in its upper phase, production costs tend to increase rapidly as the suppliers of equipment, services and labor face shortages with no easy and rapid substitution in sight. Eventually demand reacts to high prices by greater energy/resource efficiency, substitution and ultimately, with quite a time lag, a decline in demand. Supply, on the other hand, is not very elastic and will tend to continue from existing facilities well into a declining price and thus accelerates a price decline. The economic cycle reinforces the political cycle. As foreign investors are pushed out and as state-run enterprises are necessarily inefficient, investment slows down and is less productive. The economic rent (‘mineral rent’) shrinks. Shrinking government revenues then face bloated and inefficient government services necessary for the political legitimacy of the freely spending regimes sitting on top of the wheel of fortune. Their legitimacy erodes.

Petro-states as a rule have been unable to build up a self-sustaining industrial and economic base with the mineral rent. They live like ‘rentiers’: spending, to sustain their political legitimacy, but not investing and modernizing their economies by economic reform. The ‘resource curse’ does its business.⁴⁹ The focus of maximizing ‘mineral rent’ as the major objective of producing states as reflected and proposed in the study by Bernard Mommer – currently Venezuelan Vice-Minister of Petroleum⁵⁰ does not focus much on how to spend the money wisely. It simply spends itself. No petro-state has been able to pursue a consistent and successful policy in freeing itself from dependency on oil income. This is derived from the logic of oil income and is as a rule not practically changeable, whatever be the lecturing by academics, international agencies or NGOs. The more income oil generates, the less pressure there is to diversify. High points in petroleum prices are therefore rather associated with low points in terms of economic reform and industrial diversification. Furthermore, a high level of oil income reduces pressure for political reform as the control over oil income allows those who rule the petro-state to buy political support. Like all ‘rent’, dependency on unearned oil income undermines the potential for true earning power based on work, effort, initiative and ingenuity. Petro-states are like rich kids – with the ‘devil creating work for idle hands’. The inevitable decline of oil prices is then not compensated by other income-earning sectors, but is likely to provoke political crisis, reversal of state-centered economic policies and another turn of the wheel of the oil price and political cycle.⁵¹ The rentier political economy of producing states maintains and reinforces their dependency, keeps them from respecting acquired investor rights and creates a political cycle of greater volatility in addition to the price cycle. As respect for acquired rights – contractual, proprietary or civil – is an essential condition for self-reliant economic growth⁵² of societies, the price, political and legal cycles further stunt the development potential of petro-states. All of them experience great difficulty to break out of them. Mineral rent – and the focus on it – enslaves rather than liberates producing states.⁵³

It is possible that the current cycle will last longer than the previous cycle because of the unusual explosion of demand from the industrialization and creation of consumer middle classes in China and India on a massive scale. But speculation about the current cycle is beyond the remit of this essay. The one forecast that I can make is that the longer the cycle lasts, the more acute will be the implications for host states and investors described here.

	4. Types and dynamics of investment disputes

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No exhaustive survey of investment (investor–state) disputes has so far been undertaken which organizes them according to particular types of disputes. Nor has there been any systematic analysis of their ‘dynamics’, ie how such disputes emerge and progress.⁵⁴ An overall survey of information available on the ICSID (International Centre for Settlement of Investment Disputes) website (<http://www.worldbank.org/icsid>) provides information on the country of claimant investor, the respondent country, industry and the overall progress of the arbitration (from notice of claim, decision on jurisdiction, award on the merits and occasionally settlement or decision on an annulment request). This is therefore an anecdotal explanation of investment disputes.

These are features one frequently finds:

• Investment disputes almost invariably have to do with a change of government. Deals arranged with one government (and their people) are no longer accepted and are actively assaulted by the successor government. The foreign investor is at times not the principal target of the new government’s campaign, but simply a victim in a vendetta by the new against the old government (or by people in the new government against people of the old government).
  
• Structure and content of the investment transaction are rarely if ever ‘perfect’. In almost all cases there is a flaw, a lack of full perfection, detail, specificity and precision in the contractual documentation which is only identifiable once a dispute arises and legal expertise is applied to a close scrutiny of the documentation. There may have been weaknesses in the full compliance of the several contracts, consents and permits with domestic law (which rarely is very clear). Protective measures in the contract (eg stabilization and international arbitration agreements) may not exactly cover the measures taken subsequently by the government. That is because the original state–investor negotiations are based on incomplete and ambiguous language or because the subsequent government has chosen measures to evade coverage by earlier investor-protective contractual language. The state may rely on differences between the state and its state enterprise; the state may intervene by regulation or the state company may rely on regulation by the state to request a renegotiation of the contractual regime. Since most commercial operations abroad will involve the use of a chain of holding companies, contractual investment protection is not always carefully thought out in terms of which company in the corporate chain should be covered by which governmental action. Investment protection perhaps should be high on the priority of the negotiators and drafters, both in government and with the investor, but it is often not the chief concern. The foreign investor may not have extensive experience and that investment may be part of its first foray abroad. The government promoting new investment (typically at the bottom of the cycle) will send out only positive signals so that excessive attention to the political risk at the tail-end of the investment cycle may appear inappropriate and likely to poison the relationship. Typically, negotiating blockages are solved by ambiguous drafting. How this will fare in possible adjudication far in the future is rarely of great interest to the present negotiators and executives. Their reputation at stake is about ‘getting a deal’ that looks attractive to headquarters, but not how flaws in the structuring and the drafting of the transaction may become significant 10 years later – an element of ‘moral hazard’ is thus inevitable. It is only recently that the investment treaty implications for structuring investment are identified more clearly and start being taken into account when investments are organized.⁵⁵ These are the realities of the international investment process. Applying a ‘caveat investor’ principle – as some academics advocate⁵⁶ – would thus emasculate most investment protection, either by contract or by treaty as such benchmarks are far too high to be achieved in the messy reality of practical corporate and commercial life. If only ‘perfect’ investors were to be protected, there would be no need for protection at all.
  
• An intelligent way would be for such disputes to be settled early, even after notice of arbitration has been given. Indeed, in ICC commercial arbitration, most disputes are settled before the award.⁵⁷ But settlement of an investment dispute with a new government out to rescind deals it publicly attacked when it was in opposition is not politically easy. Investors should try to accommodate the public relations exigencies of the new government keen for a visible and symbolic success of dealing with a foreign investor while maintaining the economic substance of the deal. This was very much the practice of new petroleum and mineral investment at the end of the last cycle of resource nationalism in the 1980s.⁵⁸ They can also try to settle by dumping local partners affiliated with the ex-government and accepting new partners with strong links to the new government.⁵⁹ There should be little doubt that settlement of not overly politicized disputes with new governments is facilitated by bribery and patronage in favour of people with influence in the new government. That is what essentially happens in many investment disputes that are settled.⁶⁰ While these are natural and often successful strategies, they do not sit easily with companies from countries where the OECD anti-bribery convention applies, in particular from the US. They are subject to extensive corporate disclosure, transparency and anti-bribery requirements. Culturally, they are given to litigation to enforce specifically defined rights rather than to a non-US culture of continuously building and nurturing relationships.⁶¹
  
• Governments have particular difficulty settling by negotiation or mediation, when the dispute is visible, politically loaded and involves a foreign investor they had attacked when in opposition. There is no political profit to be made out of the settlement and the prospect of international arbitration or litigation means that the responsibility for the dispute is passed on to an external institution that can easily serve as a scapegoat in domestic politics. While mediation can often resolve such disputes more efficiently and can involve measures to make a settlement politically more acceptable,⁶² it has almost never been used in investment disputes. Very few of the ICSID disputes have ended in settlement.⁶³ Once a dispute ends up in litigation, it is owned by the litigation professionals. Their interests are not served by settlement or mediation, only by litigation.
  
• Long-term contracts in the oil, gas, mining, energy and utility/infrastructure industries are particularly susceptible to subsequent action by new governments resulting in an investment dispute. In all cases, it is difficult for governments to encourage investment in the low phase of the cycle. Considerable promotion and concessions (in terms of tax incentives), and investment guarantees are necessary.⁶⁴ While there may be some inbuilt adaptation mechanisms (eg resource rent tax), such contracts always reflect the low bargaining power of the government inherent in the low phase of the cycle. When the cycle moves upwards, government leverage changes. Contracts concluded earlier as a result of vigorous and persistent efforts at investment promotion in a difficult market now seem to contain excessive concessions. Inevitably, critics raise corruption, which may or may not have been associated with the deal. The investor’s investment has now become a ‘hostage’ of government policy. The heavy capital investment has been sunk; considerable risks (in particular petroleum and mineral exploration) have been taken. A dispute will only develop if such risks have been overcome and if the project – quite against the initial odds – has become successful. Disputes about ‘excessive concessions’ by the earlier government do not arise if the project failed due to those risks, in particular the high exploration risk characteristic for petroleum and mineral investment.⁶⁵ But for successful projects there is an ‘obsolescing bargain’. Investments in the areas identified are politically very visible. There is considerable political capital to be gained by attacking the ‘foreign’ control over a ‘national’ strategic resource. In infrastructure investment, private investors need to recoup their investment in purchasing and upgrading heavily deteriorated public facilities by higher usage fees. The public is not used to paying a proper fee for a proper service. So political pressure for government action against the earlier government’s privatization and investment deals is bound to rise.⁶⁶ A survey of information on investment disputes from ICSID and MIGA (Multilateral Investment Guarantee Agency) confirms the particularly vulnerable nature of investment in these industries.⁶⁷
  

To illustrate the nature of recent investment disputes – ie unrelated to the 1970s ‘NIEO’ disputes which consisted mainly of formal expropriation and the equivalent cancellation by government of long-term concessions, the following is a brief summary of disputes in the current cycle:

• The 1997 windfall tax on privatized utilities, imposed by the Blair government, catered to the dissatisfaction of the Labor Party’s left wing with Margaret Thatcher’s privatization program. It was a unilateral tax considered confiscatory since it increased the original purchase price in the privatization.⁶⁸ It did not lead to any major legal challenges. First, there was no treaty enabling direct-investor state arbitration against the UK by the – primarily USA – investors. Energy Charter Treaty investors (who could have initiated arbitration) were not involved significantly at the time in UK utilities or did not wish to rely on the ECT. Second, there was no unambiguous contractual commitment of the UK to refrain from imposing taxes post-privatization. Third, and perhaps most importantly, the significant tax was considerably less than the profits the original investors made from privatization. It was seen as a relatively reasonable way for the government to take a relatively moderate bite into post-privatization profits. The privatized utilities and their shareholders continued to do well and were not deprived of either ownership, control or the major part of their post-privatization profit. The UK windfalls tax may have inspired other post-privatization anti-investor actions but its relative moderation was not copied. Arguably, it was the most successful and uncontroversial measure directed against utility investors post-privatisation.
  
• In Nykomb v Latvia,⁶⁹ the Latvian government had promised by law to pay a special ‘double tariff’ to electricity producers using new and environmentally friendly co-generation technology. The double tariff was implemented through an agreement between Nykomb, a Swedish investor, and Latvenergo, the government-owned electricity monopoly enterprise. Latvenergo subsequently refused to honour the agreement. Its interest was rather to pay much cheaper electricity, in particular from Russian nuclear power producers across the border. In this – first – Energy Charter Treaty award the tribunal had to grapple with complex issues of umbrella clauses, indirect expropriation and, in particular, the question when a contract breach by a state-owned enterprise operating as a monopoly in a politicized and tightly regulated market could be attributed to the government;⁷⁰ there was also the special question of the relation of the Energy Charter Treaty’s quasi-attribution norm (art 22) with customary law of attribution as formulated by the ILC articles on State enterprises.⁷¹ The tribunal awarded (partial) damages to Nykomb for the breach of the contract by Latvenergo; it held the government responsible for Latvenergo’s failure, largely because of the highly regulated market and government ownership and control over Latvenergo. The tribunal eschewed dealing with the issues of the umbrella clause and art 22 ECT but found a breach of the national treatment obligation because Latvenergo had in the end paid the double tariff to domestic producers, but not to foreign Nykomb. The case raises issues that are characteristic for long-term energy investment: the dependence of foreign investors in the sector on government tariff regulation; the privileged, tightly regulated and often monopolistic role of state (or private) electricity distribution companies constituting the only viable outlet for power production; and the considerations that argued for piercing the corporate veil between state and state-owned utility companies by attribution. The case illustrates issues that are likely to re-occur in numerous energy and public infrastructure disputes which now occur with reactions against earlier privatization and with the visible role of foreign investor in politically sensitive provision of public infrastructure services. Such investments require full cost and investment recovery but the users of public services are generally not used to pay cost-covering usage charges and expect formal or implicit government subsidies. Moreover, the Nykomb case is so far the first case where the legal security of an environmental investment incentive was tested. It is therefore a prime example for the use of investment arbitration to further sustainable development by helping to secure the stability of energy efficiency incentives undermined by cheaper electricity imports.
  
• In 2004–05, Russia destroyed Yukos, a private Russian oil company partly owned by Russian, Yeltzin-area ‘oligarchs’ (in particular M Khodorkovsky) and by minority US investors, through a combination of discriminatory and retroactive tax re-assessments. Russian authorities accomplished this with large penalties and a rapid, manipulated and contrived auction which allowed state company Rosneft to purchase most of Yukos’ assets at a bargain price.⁷² Tax practices that were normal, tolerated and accepted by the Russian tax authorities were invalidated by an unusual abuse of right concept in the Russian civil code that disregarded a statute of limitation for such tax re-assessment claims. There are similarities with the UK windfall tax – ie the change of government, the pursuit of the earlier regime’s favourites and the exploitation of domestic resentment against the unexpected profitability of the privatized assets. However, different from the UK, the Russian oligarchs did not acquire the assets through a transparent and non-discriminatory tender process, but in the questionable ‘loan for shares’ deal to support President Yeltzin’s re-election bid.⁷³ Russian oil privatizations were significantly more profitable than the British ones. Yukos’ chief shareholder had used Yukos’ funds and networks to support the new President Putin’s opponents. This dimension of political opposition linked to economic power acquired through political linkages with the former regime was absent in the UK windfall tax situation. Finally, the destruction of Yukos was not based on a transparent and non-discriminatory tax, but on political manipulation of the Russian tax and judicial systems in a way that has seriously discredited them – and the claim of ‘rule of law’ and respect for property rights – in Russia.
  
• In Duke v Peru,⁷⁴ the Peruvian government initiated a tax re-assessment on Duke’s privatized electricity generation assets based on two tax minimization practices. One was based on a ‘general’ higher general depreciation rule as contrasted with a lower, specific depreciation rule applied to the former Electro-Peru’s generation assets. The other one consisted of invalidating the tax benefits of a corporate merger with modest economic substance. The merger helped the company to achieve a higher depreciation because it allowed re-valuation of the corporate assets at the higher market rate. The ICSID case is based on a ‘Legal Stabilization Agreement’ obtained by Duke in the course of purchasing the privatized assets. Its interpretation is currently before an ICSID tribunal based on an ICSID arbitration clause in the contract. The Duke case does not have the heavy political connotations as the Yukos case. But it does reflect the political cycle. The earlier Peruvian government heavily promoted privatization in a time of economic emergency to re-start the economy. It guaranteed legal stability, following the successful ‘Chilean’ model to overcome its high political risk rating. The successor government was influenced by the re-emergence of economic nationalism (after economic recovery) and resentment against foreign privatization investors. This change in sentiment towards privatization investors seems to have provided some momentum to the deployment of taxation rules, in particular the opaque and easily abused principle of ‘economic substance over form’.⁷⁵ This principle, used as well in the destruction of Yukos under the Putin presidency in Russia, allows to question virtually every business transaction as tax considerations are likely to be part of any planning for commercial transactions.
  
• Venezuela, over the last several years, has forced most or all foreign oil companies to accept a revision of contract terms (with PDVSA, the state company) which significantly worsened the ownership and tax position of foreign investors.⁷⁶ This has been done under the threat of unilateral legislation and/or expropriation. Similarly, companies in Bolivia have been coerced to accept significantly less favorable terms under the threat of full nationalization and physical occupation of their operations. In both the cases, foreign investors were seen by the present governments as closely associated with earlier, more pro-investment regimes. The attack on foreign investors was presented as a fundamental reversal of the former governments’ policies. There were also elements of internal ethnic conflict between the indigenous majorities represented by the new regimes against the ‘white’ upper and middle classes represented by the earlier governments with a traditional ‘Western’ and US orientation. Class and race probably play a role in both the situations. There is also an element of vociferous anti-Americanism present in the Venezuelan case.
  
• Both the governments’ economic nationalist policies reflect the upper phase of the resource industry’s cycle and the corresponding political cycle. The Venezuelan case displays traits of a Socialist and state-oriented attitude – or ‘war economy’ – towards activities in the dominant oil and gas sector. Most companies have accepted the renegotiated terms on the premise that it is better to continue to have a smaller share in the more profitable petroleum assets than being left with a combination of full exit and a compensation claim requiring protracted international arbitration under available contractual or BIT-based arbitration with no guarantee of compliance with an award. However, some companies with assets that are less profitable are resorting to arbitration with the hope that a subsequent government, in the downwards cycle, may be willing to come to a settlement and pay on an eventual arbitral award.⁷⁷ Experience in other cases, eg the Libyan nationalizations of the 1970s and the Peruvian expropriations in the mid-1980s, illustrates that when the political and economic cycle moves downwards and investment promotion comes back on the agenda, old disputes with open claims get settled. Should oil prices decline and the coercively renegotiated contracts no longer be economically viable, then such a strategy might recommend itself. Should the companies which have accepted renegotiation develop second thoughts over the wisdom of such acquiescence, the legal issues raised by the companies will be that coercive renegotiation is a breach of the ‘fair and equitable’ treatment standard⁷⁸ as opposed to the claim by governments that companies ‘freely’ waived any right arising before the renegotiation out of applicable treaty obligations of the host states.
  

Glamis v US⁷⁹ is not related to privatization but shows another perspective of the interventionism of western countries into the natural resources industry. It essentially concerns the US Federal and California administrative and regulatory action to prevent development of a gold mine asserted by the adjacent Quechan Native American tribe to be in conflict with spiritual pathways and sacred sites in the California desert. The California action was undertaken with the express purpose of preventing the mine, but justified as environmental measures imposing an intentionally prohibitive, novel and unexpected reclamation requirement. The Glamis case is indicative of modern trends. The traditional priority of mining in land-use decision-making under mining laws is being revised in favor of indigenous people⁸⁰ (with the idea that not the state, but the foreign investor should sacrifice its rights for such protection). The state intervenes in the high-risk phase between exploration and mine development, ie after the investor has assumed the significance and natural resources characteristic and unique exploration risk, with a regulatory innovation. The case illustrates that the mineral industries are now being exposed to a higher risk in both developed and many developing countries due to a rising popular sentiment against it. Pro-indigenous and anti-gold-mining sentiments coalesce in cases like this; this changes the political and regulatory equation relevant to the industry. It illustrates the growing risk of the lack of ‘social acceptance’ of oil, gas and mineral extraction; an activity that may have intense, but very localized, effects that pose very little widespread environmental issues compared to most of the hydrocarbon-based energy consumption. Developed economies cannot therefore necessarily claim to offer greater protection of acquired rights. To the contrary, they may offer a model of how to undo acquired rights by stealth through the deployment of regulation and tax rules, but also in the even better camouflaged ways of enforcement. Such regulatory and administrative practices can, at face value, be made to appear innocuous and legitimate but achieve the same effect than the cruder instruments of confiscation, expropriation and nationalization used in the past primarily in developing countries. This suggests that the future of international investment law will be much concerned with formal expropriation as with the impact of regulatory measures on the proper functioning of property rights.⁸¹

The Glamis case involved changes of government and government policy. The dispute had to do with a change of popular attitudes that reflected itself in a change of regulation, administration and interpretation of open-ended clauses. The claim was raised under NAFTA ch XI, in particular under art 1110 that deals with ‘indirect expropriation’. The US defense reflects the normal instinct of state respondents by emphasizing full exposure of property rights to government regulation, even when there is an unexpected change. While the US argument is formulated as if the issue were an ‘indirect taking’ under the US constitutional law, it reflects a very statist view of individual property rights (under the cover of ecological, cultural and religious rights’ advocacy) which can easily be adopted by other authoritarian, statist or socialist governments in investor–state arbitration. This has already happened as the US arguments have already been relied on in the defense of a Latin American government against a US privatization investor.⁸² The Glamis v US case illustrates that the issue of property rights versus regulatory change is not just an issue for developing or ex-socialist countries but cuts through the relationships between private investors and regulating states throughout the world.⁸³

A recent complex of disputes, which is not public, originated in the significant oil price increases and resulting – in the eyes of the host state – in ‘windfall’ for the investor, an international oil company. Whatever the oil price, the major share of the ‘petroleum rent’ is captured under most fiscal regimes by the host state. This is simply a consequence of high marginal tax rates (up to 90% and more) achieved by a combination of income tax, royalty or quasi-royalties implicit in production-sharing arrangements with a cost-recovery cap, production-sharing percentages and windfall-tax add-ons (such as a rate-of-return-based resource rent tax). Nevertheless, an investment project that was considered economically feasible by the investor on the basis of a 15 US $ per barrel price will generate a substantial return to the oil company at 100 US $ per barrel – even if most of the excess over 15 US $ per barrel is taxed away and even if the capital and the operating costs have inflated substantially.

In this dispute scenario, two distinct though linked issues can be identified. First, the state company (party to a production-sharing contract) was subject to a change in its own status, that shifted income generated by the upstream oil project from the state company to the state. Second, a new special windfall tax was imposed – not dissimilar to host state behaviour in developed countries with substantial upstream oil and gas production. The first issue leads to the question of how an ‘equilibrium’ clause in the Production-Sharing Agreement should be interpreted. Can the state enterprise rely on the equilibrium clause (the specific language and contractual context evidently controlling the interpretation) if income is simply shifted from the state enterprise (legally separate but politically and closely integrated with the state) to the state? There is no arbitral precedent for that question. Most discussion of stabilization clauses (the equilibrium clause being a modern version of it) is merely descriptive. Prof. Berger in a recent article briefly identifies the issue.⁸⁴ The solution has to come from the analogous application of the extensive jurisprudence available on the right of state enterprises to invoke force majeure clauses when they intervene.⁸⁵ Most of the well-known precedent cases deal with disruption in the performance of a sales contract by government prohibition on or revocation of licenses. This situation is quite different from the invocation of a reciprocal equilibrium clause in a long-term upstream petroleum production-sharing contract, perhaps conceptualized as a sui generic form of contract including elements of joint venture, long-term services, management and financing contracts, and also with elements of a public concession. The analogy can be corroborated by reference to international soft-law instruments on harmonization – eg the Unidroit Rules of International Contracts,⁸⁶ from a comparative private and arbitral law perspective and from an international law perspective by application of the ILC rules on State Responsibility, in particular arts 4, 5 and 8 to state enterprises.⁸⁷ One can reach the same result both from an international commercial law perspective as from an international law perspective applied to the task of contract interpretation; from a legal and theoretical point of view, the interesting feature of this dispute is the argument for parallel application (and debate) of both comparative contract law as indicated in soft-law international harmonization instruments (such as the Unidroit and related model rules) and public international law instruments such as the influential ILC articles on state responsibility or the analogous reference to the Vienna Convention on Treaties.⁸⁸

The second leg of this overall dispute raises the question if the imposition, by the state, of a new additional petroleum tax can be shifted, via the equilibrium clause now operating more as a stabilization clause, to the state enterprise. Stabilization clauses have evolved from simple and legally questionable ‘freezing clauses’⁸⁹ to a much more modern and subtle instrument whereby the state enterprise, as a party to the production-sharing (or similar) contract, assumes the risk of government action affecting the contractual equilibrium and thus compensates the foreign partner for a change in the fiscal parameters of the contract.⁹⁰ A new tax not contemplated in the original deal is arguably the major political/fiscal risk against which traditional stabilization clauses and modern stabilization by renegotiation or equilibrium clauses were meant to provide contractual protection. The specific interpretation of such strategic clauses is usually difficult. Typically there will be ambiguities not spelled out, often intentionally, in negotiation and drafting. There is also the issue as to what extent concepts of national law, comparative law or authoritative soft law (eg Unidroit rules) should influence the application of specific contract clauses. On the one hand, the specific contract language should be seen as a special rule which can provide a solution that is different from generally applicable and dispositive national law. On the other hand, it is natural to look at national law, comparative and soft law and at the particular negotiating context to clarify the scope of an ambiguous and open-ended contract clause. In the English legal tradition, arguments based on negotiating history are discouraged. International tribunals will, however, often be influenced by arts 31 and 32 of the Vienna Convention which, even if not directly applicable to commercial contracts or ‘state contracts’ relating to a foreign investment, express best an international consensus on the interpretation methodology. Under the Vienna Convention, the history of negotiation can be relied upon, but only as a secondary source.⁹¹

An issue that arises frequently in emerging production-sharing contract disputes is the meaning of ‘equilibrium’. Equilibrium could be understood as a iustum pretium in terms of an equitable relation between the contributions by both sides; a substantial rise in profitability due to much higher oil prices could with this perspective in mind mean that the parties – and ultimately a tribunal – have to determine what the ‘equitable’ sharing should be, ie how the unexpected rise in petroleum rent should be shared. This, as in any attempt to define ‘equilibrium’, requires taking account of the risks originally taken by the parties. In upstream oil and gas development, that is the risk of unsuccessful exploration, higher than expected costs, serious decline of oil prices and perhaps political insecurity. Equilibrium can further be understood as the simple maintenance of the ‘original’ deal, with any government measure changing that original deal being viewed as a compensable distortion.

But some PSCs qualify the ‘equilibrium’ as ‘normal’. This raises the question whether the recent prolonged oil price, and thus profitability increase, is ‘normal’, ie presumably within the perspective of the original negotiators or whether ‘normal’ makes a reference to external influences on the contract. Equilibrium could also be conceptualized as the ratio of sharing the petroleum rent agreed in the original PSC. This means that percentage should be maintained, if need be by compensation, if external events (such as unexpected oil price developments upwards or downwards) or more internal events (such as government tax measures) modify that percentage. Finally, it could be understood in a procedural rather than material way as to how the parties would have agreed had they taken the current price increase into account as a possible part of the future’s scenario. But, one can not take the ‘high oil price’ scenario as the only possibility – it needs to be balanced by lower oil price scenarios and the occurrence of negative exploration and other risks. Such an equilibrium analysis might well suggest that the contract the parties originally negotiated is the contract they would have negotiated had they thought about the current high oil price scenario (which they probably have). Equilibrium is hence a fluid and slippery concept that reminds – and perhaps links – to how comparative law handles a fundamental change in a contract’s underlying circumstances. Comparative law has no uniform understanding. English legal culture takes a very restrictive view while civil law systems (at least in theory and in practice, probably only for an economic crisis) take a more extensive view.⁹²

To conclude: While it is possible to identify legal concepts and authoritative principles to use for interpretation of equilibrium and similar stabilization clauses, it is not possible to come up with a general solution without a very detailed, indepth analysis of the particular equilibrium clause in its very particular contractual, regulatory, fiscal, industry and negotiating context. There is little if any arbitral jurisprudence because what there is tends to be confidential and parties may well investigate and sometimes test in pre-arbitral proceedings the relative strength of their legal position. However, this will be simply a starting point for a commercial renegotiation serving one or both parties better than a full-fledged and protracted arbitral litigation. That does not mean that the legal issues are without commercial significance but rather that they are one factor of working together out of which a renegotiated new arrangement arises.

The SwePol dispute⁹³ concerned the contractual arrangements (including price and trade directions) in an electricity interconnector between the two leading state-owned electricity enterprises in Sweden and Poland. Essential assumptions (namely domestic prices and power requirements in Poland) had undergone a substantial change since the contracts were concluded. The contracts were no longer viable for the Polish PSE (Polskie Sieci Elektroenergetyczne). On the face of it, the contracts were specific and clear, with little or no ambiguity. However, the dispute involved a number of other actors – the Polish and Swedish regulators, a Swedish electricity network operator, equipment suppliers and the EU Commission. The three regulatory regimes were not clear on their rules and they were in a state of change. Both countries had joined the EU after the contracts were concluded so that EU competition law, in particular the rules on essential facilities such as electricity interconnectors, came into play. Both the state companies wanted to avoid litigation and arbitration, which would have involved considerable cost, risk and delay and shut down the interconnector operations for an indefinite period. As a result of mediation, the renegotiated agreements provided them with considerable mutual profit potential. Both parties had serious risks to manage. The Polish side ran the risk of a massive award against it which might have bankrupted it. The Swedish side risked the questioning of the original contracts under EU competition law, the difficulties of enforcing an award in Poland against a strategic Polish state company and political intervention by governments, regulators and the EU Commission. This dispute demonstrates the power of pro-active, commercially oriented mediation. It also illustrates how difficult it is to achieve ever-lasting and legally binding contractual commitments in developed countries when competition law casts a shadow on the sanctity of a contract.

Argentina has a history of encouraging large public infrastructure and energy investments; but also of repudiating deals made by earlier governments, often under the pressure of economic crisis and concomitant political and ideological re-alignment. Default on debt and revocation of concession contracts has a history of two centuries; possibly, a cycle from investment promotion to investment taking roughly equivalent to a generation, ie 25–35 years, can be identified.⁹⁴ In 1958, it revoked the ‘Frondizi’ petroleum contracts. In the 1990s, it reversed policy and introduced far-reaching privatization. After 2002, following a largely home-made economic crisis, it unilaterally cancelled contractual commitments with foreign investors raising the defense of ‘economic necessity’. Numerous ICSID cases based on Argentine BITs are ongoing, with some awards ruling against Argentina.⁹⁵ Argentina has not yet paid compensation as required by ICSID awards already rendered. It has, however, settled with some investors ready to relinquish their ICSID/BIT claims – as it has settled with many, though not all, foreign bondholders.⁹⁶ One can expect that all the investor claims will eventually be settled, with some give and take. The ICSID award provides leverage to the claimant investor while the difficulty to collect the award provides leverage to Argentina. This occurred with the famous Libyan awards of the 1970s, which in the end were settled by little publicized payments by Libya.⁹⁷

In two other non-public disputes, one before a domestic tax court and the other before an international tribunal, the issue was the application of a production-sharing contract’s accounting and tax-related rules. The interaction between the provisions of a PSC and the rules of governmental tax regulation is always complex. There are conceptual difficulties on how the provision of a contract between two parties should impact on the way a tax rule is applied. If the PSC is with a state company, then the stabilization clause (frequently now an equilibrium clause) will often allocate the risk and burden of new regulation to the state company. In the domestic tax case, the tax authorities questioned the overhead claimed by a foreign oil company as part of the cost recovery that is typically allowed under a PSC. At issue was the interpretation of the ‘Accounting Rules Annex’ of the PSA. The company, relying on an international comparative survey of overhead rules in PSAs and petroleum legislation as well as OECD soft-law tax instruments, was able to persuade the domestic tax court that its overhead charge was not excessive but in accordance with the international practice.

In the other, more difficult, case in front of the international arbitration tribunal, two strategic cost items were at issue. First, could the money spent by the foreign oil company to ‘carry’ the state oil company through part of the exploration phase be claimed as a recoverable cost under the PSC and factored into the calculation of a resource-rent tax. Second, could an internal accounting provision made for offshore decommissioning at the end of the project be equally factored into the calculation of the resource rent tax. The difficulty was that the future liability (ie offshore decommissioning) was certain. However, the company had only made an internal accounting provision for a ‘sinking fund’ gradually accumulating the necessary amounts and had not separated such an internal ‘provision’ into a separate, external escrow account, even though that at the time of the future decommissioning there would be no more production income to allow an off-setting of the decommissioning costs. The tribunal accepted the state company ‘carry’ (ie monies that represented something akin to the cost of purchase of the participation) as part of the cost recovery and calculation of the additional profits tax, but refused to accept the decommissioning internal ‘provision’ as a cost recovery item since the company had not lost control over the accumulated monies. Both the disputes appear to involve very technical tax issues. But they also represent the tax authorities’ greater scrutiny and pressure for income exercised through an interpretation which is more favourable to the state. As sensitive issues in such contracts are often left intentionally or by oversight ambiguous, interpretation of ambiguous provisions is the tax authorities’ method to gradually tighten the tax screws without resorting to an overt breach of the contract or exercise of tax powers outside the contract. The other instrument, already discussed, is reliance on the unlimited potential of general anti-avoidance and ‘economic substance over form’ concepts to disregard any transaction accompanied by a tax optimization intention.⁹⁸

What does this survey of recent investment and related disputes indicate for the question of the effectiveness of property and contract rights of foreign investors protected under contractual and international treaty instruments? First, it is evident that there is no absolute security. Contractual instruments such as stabilization and equilibrium clauses, and also investment protection treaties, have not been able to fulfil completely their original promise and investors’ (and capital markets’) expectations.⁹⁹ The many instruments invented and negotiated in the 1980s and 1990s to make fiscal regimes more flexible and self-adaptive in response to changing economic conditions – resource rent tax, additional profits tax, flexible price-related royalties – have not been able to avoid investor–producer state disputes in a time of constant high oil a