Strategy

Energy policy: Law of the land

Oil companies are finding it hard to deal directly with government entities.

In the earliest days of the global oil industry, big international oil companies such as ExxonMobil and Chevron were often granted generous access to develop a country’s oil resources. Since then oil-producing countries have come to realize the value in their resources, and there has been a resulting shift in control of oil reserves from the old oil giants to governments and national oil companies such as China’s CNOOC, Petroleos Mexicanos (Pemex) and Brazil’s Petrobras.

Today, an estimated 77% of total global oil and natural gas reserves are state-owned, and that percentage should only get higher in the future. That trend is also changing the way large independent oil companies — and the oil service companies who work for the majors — do business since they now have to deal more often with state-owned firms rather than the traditional international oil companies. “These are unusual and frustrating times for the majors,” according to a recent article in the Journal of World Energy Law & Business. “The [state-owned firms] have a competitive advantage, because many governments prefer anything other than a western major these days.”

Those companies typically stuck to the terms of an agreed-upon contract. But in dealings between businesses and the state, governments are subject to the will of the local people (who are constantly pressing for more services from their legislators), so there is sometimes a temptation to rewrite the terms of contracts in their favour. And that has brought the risk of expropriation into the game.

But Canadian companies looking to work in the global oil and gas industry can maximize the possibility that any profits will end up in their bank accounts at the end of a contract and not in state coffers, says Frank Alexander, a Calgary-based international petroleum lawyer with Fraser Milner Casgrain. A member of the Association of International Petroleum Negotiators, a group of 2,200 lawyers created back in the ’80s, Alexander is often in the thick of negotiations between governments and oil companies. While he admits there is likely little that can be done if a government is religiously committed to fleecing an international oil company, globally minded industry execs need to think about these legal issues, not just the job at hand. For instance, some suspect the soap opera around British Petroleum’s venture in Russia, TNK-BP, is being caused by their Russian partners who simply want the foreigners to give up their half-ownership position.

“The big word today is stabilization,” says Alexander. Embedding this key concept in a contract is a matter of enshrining the rights to monetize the investment, fiscal stability and enforceable international arbitration in any contract. Alexander calls these the “three pillars of security of investment,” (a phrase that also happens to be the title of a chapter he wrote on the subject).

Of course, it’s tricky to ensure these principles remain baked into a deal when contracting with the entity that creates the laws in the first place, says Alexander. But the first thing to do is to make sure the principles exist in a host government’s petroleum law or foreign investment law. If not, a “freezing,” “economic balancing” or “government pays” mechanism needs to be negotiated into the contract. Referring to international law as the governing law on contract (rather than the host country’s domestic law) might help ensure the three principles will be respected as well. After all, if a government knows it’s going to end up in an international court of law, or in front of an international arbitration panel, the idea it might stand out as a country that doesn’t abide by its contracts might be enough to keep the peace.

If the oil and gas industry sounds a little more risky than it used to be, it is. “This is the new dynamic in the industry,” says Alexander. And companies need to think about that political risk before they get in bed with a state.