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1 This Webcast Will Begin Shortly If you have any technical problems with the Webcast or the streaming audio, please contact us via at: Thank You! RISK MANAGEMENT IN INTERNATIONAL OIL AND GAS Presented by ACC s Energy Committee sponsored by Blake, Cassells & Graydon LLP August 15, 2007 Association of Corporate Counsel 1

2 Page 3 Panel Presenters: Michael J. Laffin Partner, Blake, Cassels & Graydon LLP Craig Spurn Partner, Blake, Cassels & Graydon LLP Moderator: Nicole Spaur Senior Counsel, Sprague Energy Corp. Page 4 Outline Types of International Petroleum Agreements Potential Risks When Investing in Foreign Countries Geological Prospectivity Fiscal Regime Political Regime Legal Regime Upsetting the Commercial Balance Sources of Vulnerability Responding to Risks 2

3 Page 5 Outline Clauses and Concepts Applicable Laws Force Majeure Clauses Hardship Concept Renegotiation Clauses Stabilization Clauses Renegotiation vs. Stabilization Clauses Conclusions Page 6 Concession Agreement State grants exclusive exploration and development rights to an International Oil Company ("IOC") for a designated area IOC provides financing, pays taxes and royalties but receives all production Often referred to as a "lease", "license" or "permit" 3

4 Page 7 Service Contracts IOC pays all exploration and development costs IOC recovers these expenditures through a discounted purchase price, cash payments, or production take State retains production upside, although it may grant a share of oil produced Page 8 Production Sharing Agreement ("PSA") State delegates exploration and development rights to IOC IOC and National Oil Company ("NOC") enter into a PSA with IOC where IOC acts as contractor, finances exploration and development Oversight and management of operations by NOC If successful, IOC will recover its costs and earn a profit by receiving a share of production 4

5 Page 9 Potential Risks when Investing in Foreign Countries Geological Prospectivity Fiscal Regime Political Regime Legal Regime Page 10 Vulnerability of International Petroleum Agreements Long-term contracts Sunk costs Changing expectations 5

6 Page 11 Responding to Risks Spreading risk Insuring against risk Defending against risk Structuring and managing the risk Contracting considerations Page 12 Applicable or Governing Law Whose laws? When are principles of international law used? What law is chosen? 6

7 Page 13 Arbitration Is this a dispute that qualifies for arbitration? Legal Dispute vs. Difference of Opinion Page 14 Arbitration Doubtful Cases The Traditional "Dispute Oriented" Understanding of Arbitration The expression "legal dispute" has been used to make clear that while conflicts of rights are within the jurisdiction of an arbitrator, mere conflicts of interest are not. The dispute must concern the existence or scope of a legal right or obligation, or the nature or extent of the reparation to be made for breach of a legal obligation. 7

8 Page 15 Arbitration as a Means of Contract Adjustment Should arbitration be a method for contractual adjustment? A multitude of modern developments supports the assumption of a more extensive jurisdiction for arbitral tribunals, including the authorization to adjust and adapt contracts. Sanctity of Contracts vs. Fairness Page 16 Force Majeure Clauses What is a force majeure clause? Requirements for force majeure the force majeure event is an impediment beyond the control of the claiming party; the event prevents or delays performance under the contract, in whole or in part; the event makes performance under the contract imprudent, substantially more difficult or expensive; 8

9 Page 17 Force Majeure Clauses the event was not due to fault or negligence of the claiming (or non-performing) party; and the party claiming excused non-performance must have exercised reasonable diligence to overcome or remove the force majeure event. Is unforeseeability a requirement? Events triggering force majeure Page 18 Force Majeure Clauses Economic force majeure - is there such a concept? Effect of declaring force majeure 9

10 Page 19 Interpetrol v. Kaiser T agreed to purchase oil from O T agreed to sell specified quantities of oil to K K was to sell such product to I Significant increase in oil price O seeks release from contract with T T releases O from contract Allowing O to sell oil to a third party Page 20 Interpetrol v. Kaiser Consequently K could not complete its contract with I and claimed force majeure excusing its failure to perform due to loss of oil supply I claimed force majeure only excused unforeseeable involuntary events 10

11 Page 21 Hardship Concept UNIDROIT Principles What is the hardship concept? "There is hardship where the occurrence of events fundamentally alters the equilibrium of the contract either because the cost of a party's performance has increased or because the value of the performance a party receives has diminished; Page 22 Hardship Concept the events occur or become known to the disadvantaged party after the conclusion of the contract; the events could not reasonably have been taken into account by the disadvantaged party at the time of the conclusion of the contract; the events are beyond the control of the disadvantaged party; and 11

12 Page 23 Hardship Concept the risk of the events was not assumed by the disadvantaged party." Effects of hardship Can the hardship concept lead to a renegotiation? Does unprofitability constitute hardship? Is there an inherent duty to renegotiate a hardship situation? Page 24 Renegotiation Clauses What are they? A clause that provides a method for altering the economic balance between the parties. Definition of "Trigger Events" Precise vs. imprecise terms Parties' obligations in reaching agreement General obligations during negotiations 12

13 Page 25 Renegotiation Clauses Various examples Aminoil Clause If, as a result of changes in the terms of concessions now in existence or as a result of the terms of concessions granted hereafter, an increase in benefits to Governments in the Middle East should come generally to be received by them, the Company shall consult with the Ruler whether in the light of all relevant circumstances, including the conditions in which operations are carried out, and taking into account all payments made, any alternations in the terms of the agreements between the Ruler and the Company would be equitable to the parties. Page 26 Renegotiation Clauses China Clause "If a material change occurs to the Contractor's economic benefits after the effective date of the Contract due to the promulgation of new laws, decrees, rules and regulations or any amendment to the applicable laws, decrees, rules and regulations of the People's Republic of China, the Parties shall consult promptly and make necessary revisions and adjustments to the relevant provisions of the Contract in order to maintain the Contractor's normal economic benefits hereunder." 13

14 Page 27 Renegotiation Clauses Ghana Clause It is hereby agreed that if during the term of this Agreement there should occur such changes in the financial and economic circumstances relating to the petroleum industry, operating conditions in Ghana and marketing conditions generally as to materially affect the fundamental economic and financial basis of this Agreement, then the provisions of this Agreement may be Page 28 Renegotiation Clauses reviewed or renegotiated with a view to making such adjustments and modifications as may be reasonable having regard to the Operator's capital employed and the risks incurred by him always provided that no such adjustments or modifications shall be made within 5 years after the commencement of production of petroleum in commercial quantities from the production area and that they shall have no retroactive effect. 14

15 Page 29 Renegotiation Clauses Art Introduction of New Laws and Regulations If after the Effective Date, new law(s) and/or regulation(s) are introduced in Vietnam adversely affecting Contractor's interest, or any amendments to existing laws and/or regulations are made then the Parties shall meet and consult each other and shall make the necessary changes to this Agreement to ensure that Contractor is restored to the same economic conditions which would have prevailed if the new law and/or regulation or amendment had not been introduced. Page 30 Renegotiation Clauses Qatar Clause The "Model Exploration and Production Sharing Agreement" of the Sheikdom of Qatar of 1994 contains among others, the following clause: Art Equilibrium of the Agreement Whereas the financial position of the Contractor has been based, under the Agreement, on the laws and regulations in force at the Effective Date, it is agreed that, if any future law, decree or 15

16 Page 31 Renegotiation Clauses regulation affects Contractor's financial position, and in particular if the customs duties exceed... percent during the term of the Agreement, both Parties shall enter into negotiations, in good faith, in order to reach an equitable solution that maintains the economic equilibrium of this Agreement. Failing to reach agreement on such equitable solution, the matter may be referred by either Party to arbitration pursuant to Article 31. Page 32 Renegotiation Clauses Duty to Agree According to several commentators, renegotiation clauses only contain an obligation on the parties to make the best possible effort to reach an agreement, they do not require the parties to actually reach an agreement. 16

17 Page 33 Stabilization Clauses What are they? A specific commitment by the foreign country not to alter the terms of the agreement by legislation or other means, without the consent of the other contracting party. Risks addressed financial requirements Page 34 Stabilization Clauses expropriation labor law increases in energy and infrastructure usage costs changes to accounting rules mandated local service and supply contracts imposition of new environmental obligations 17

18 Page 35 Types of Stabilization Clauses Intangibility Clause government cannot unilaterally modify or terminate the contract Strict Adherence governing law of the contract shall be that of the contracting state at the time the contract was executed Goodwill Clause contract shall be performed consistently with goodwill or in good faith Page 36 Types of Stabilization Clauses When applied and how interpreted International arbitration decisions Lena Goldfields, Ltd. v. U.S.S.R. (1930) Choice of Law Clause - "parties based their relations... on the principle of goodwill and good faith. Stabilization Clause - government promised to make no alteration in the agreement... except with Lena's consent. 18

19 Page 37 Sapphire International Petroleum Ltd. v. National Iranian Oil Co. Choice of Law Clause - parties agreed to carry out the provisions in accordance with principles of good faith and goodwill Stabilization Clause - "no general or statutory enactment, no administrative measure or decree of any kind, made either by the government or by any governmental authority in Iran (central or local), including NIOC, can cancel the agreement or affect or change its provisions, or prevent or hinder its performance. No cancellation, amendment or modification can take place except with the agreement of the two parties." Page 38 Saudi Arabia v. Arabian American Oil Co. ("Aramco") Government of Saudi Arabia entered into oil concession agreement with Aramco Aramco given exclusive right to transport oil extracted from its concession area Government of Saudi Arabia reaches agreement with third party under which third party given priority for the transport of Saudi Arabian oil 19

20 Page 39 Saudi Arabia v. Arabian American Oil Co. ("Aramco") Aramco concession clause contained a stabilization clause Arbitrator's finding recognized the validity of stabilization clauses under international law Page 40 Azerbaijan's Stabilization Clause The rights and interests accruing to Contractor (or its assignees) under this Agreement and its Subcontractors under this Agreement shall not be amended, modified or reduced without the prior consent of Contractor. In the event that any Governmental Authority invokes any present or future law, treaty, intergovernmental agreement, decree or administrative order which contravenes the provisions of this Agreement or adversely or positively affects the rights or interests of Contractor hereunder, including, 20

21 Page 41 Azerbaijan's Stabilization Clause but not limited to, any changes in tax legislation, regulations, or administrative practice, or jurisdictional changes pertaining to the Contract Area, the terms of this Agreement shall be adjusted to re-establish the economic equilibrium of the Parties, and if the rights or interests of Contractor have been adversely affected, the SOCAR shall indemnify the Contractor (and its assignees) for any disbenefit, deterioration in economic circumstances, loss or damages that ensue therefrom. Page 42 Azerbaijan s Stabilization Clause SOCAR shall within the full limits of its authority use its reasonable lawful endeavours to ensure that the appropriate Governmental Authorities will take appropriate measures to resolve promptly in accordance with the foregoing principles any conflict or anomaly between any such treaty, intergovernmental agreement, law, decree or administrative order and this Agreement. 21

22 Page 43 Renegotiation vs. Stabilization Clauses Fixed vs. Flexible Legal Situations Page 44 Conclusions Make every effort to understand the foreign country's legal regime for petroleum exploration and development. Appreciate the importance of sovereignty considerations in a petroleum legal regime. Assess trends in regulation. 22

23 Page 45 Conclusions Understand the host government contract and do not underestimate the importance of the relationship between the host government and the investor. Ensure the contract includes an arbitration clause that empowers arbitrators to carry out what you envision. Thank you for attending another presentation from ACC s Desktop Learning Webcasts Please be sure to complete the evaluation form for this program as your comments and ideas are helpful in planning future programs. You may also contact Sherrese Williams at williams@acc.com This and other ACC webcasts have been recorded and are available, for one year after the presentation date, as archived webcasts at You can also find transcripts of these programs in ACC s Virtual Library at 23