Oil & Gas: To Hell with the Contracts….

The Nigerian government is focussing on PSC and joint venture agreements in its attempts to extract more from Oil & Gas: as part of our occasional series on key management issues in the Oil & Gas industry and the strategic context needed to succeed, we asked Bryan Gundersen, one of the world’s leading lawyers and an associate of WBC, to comment on the governance and legal issues arising from the current Nigerian government initiative.  Bryan’s next course is in Lagos at the end of November.

….It’s all About Governance!bng_profile

Right?

In any discussion on Oil & Gas matters, the focus is on the need for robust but competitive legislative and fiscal regimes, efficient regulators, experienced industry participants and contracts which allocate risk efficiently and minimise transaction costs.

Recent and ongoing developments in Nigeria are a reminder that while these are all important, they all fall down in the absence of good governance.

Nigeria’s new President, Muhammadu Buhari, is trying to deal with government and institutional corruption and renegotiate Production Sharing Contracts (PSCs) and joint venture agreements with the oil majors, yet there are a number of other issues which must be addressed. They all have a common theme; the importance of good governance, whether the renegotiation of the PSCs, the Nigerian National Petroleum Corporation (NNPC), the oil & gas industry’s regulatory bodies, the control the scale of oil theft, or  the award of discretionary PSCs.

What is the basis for the renegotiation of the PCSs with the oil majors?

PSCs commonly provide for `stabilisation` or ‘freezing’ i.e. contractual mechanisms to preserve the benefit of specific economic and legal conditions which the parties considered to be appropriate at the time they entered into the PSC. The aim is to insulate the contractual relationship from any material adverse effect or change. The freezing or stabilization clauses may not be a guarantee against the bona fide State’s exercise of sovereign authority in the public interest but they can form the basis for compensation.

More modern clauses aim at protecting the economic equilibrium of the contract, rather than freezing the existing fiscal frameworks. They provide for a re-balancing (renegotiation) of the benefits of the contract in the event of a unilateral action by the host government e.g. an increase in fiscal obligations that adversely affects the foreign investor may trigger a provision that other parts of the fiscal regime must be adjusted.

There are various forms of balancing provisions. For example:

  • Stipulated economic balancing which provides for automatic amendment in a specified way (e.g. by way of readjustment of the profit petroleum split). The Ecuadorian Model PSC uses this type of balancing provision.
  • Non-specified economic balancing which, while providing for automatic amendment, does not provide for a specified amendment and does not require the agreement of the parties for such an amendment. The PSC between the State Oil Company of Azerbaijan and Kura Valley Development and Socar Oil (an affiliate of the State Oil Company) uses this type of balancing provision.
  • Negotiated economic balancing which requires the parties to negotiate amendments to the PSC. The current Indian Model PSC uses this type of balancing provision.

They can be categorised in other ways. For example:

  • Full Freezing Clauses which freeze both fiscal and non-fiscal law with respect to investment for the duration of the project.
  • Limited Freezing Clauses which freeze a more limited set of legislative actions.
  • Full Economic Equilibrium Clauses protect against the financial implications of all changes of law, by requiring compensation or adjustments to the deal to compensate the investor when any changes occur.
  • Limited Economic Equilibrium Clauses which protect against financial implications of some limited set of changes in law or after specified costs are incurred. They require compensation or adjustments to the deal to compensate the investor only when the covered changes occur.
  • Full Hybrid Clauses which protect against the financial implications of all changes of law, by requiring compensation or adjustments to the deal, including exemptions from new laws, to compensate the investor when any changes occur
  • Limited Hybrid Clauses which protect against financial implications of some limited set of changes in law or after specified costs are incurred. They require compensation or adjustments to the deal, including exemptions from new laws, to compensate investor only when the covered changes occur.

In the case of the Nigerian PSCs subject to renogiatation, entered into in the early 1990s, one understands they have three re-balancing clauses such as (i) re-examination of the fiscal terms, if oil prices reach US$20, (ii) a re-examination and re-negotiation of the fiscal terms for more equity in favour of the government, should there be discoveries above 500 million barrels and (iii) an overall review of the PSC after 15 years. They reflected the circumstances then prevailing, but by 1997, most PSC major contractors operated fields with reserves exceeding 500 million Barrels and by 2001, oil prices had surged far ahead of $20 per barrel and now, more than 15 years have expired.

Hence, the current round of renegotiation undertaken by Nigeria’s new President, Muhammadu Buhari.  However, what are the parties’ respective BATNAs (the parties’ respective best alternative to a negotiated outcome)? One assumes that each, the Nigerian government via NNPC and the oil major PSC contractors, have access to international arbitration in the absence of a negotiated outcome.

The re-balancing clauses have been effective in terms of allowing allowing a renegotiation and perhaps an improved position for the NNPC and the Nigerian government, but success is dependent on the good governance of the NNPC.

President Buhari has commenced a programme of reform to transform the NNPC into an effective organization and control corruption.

Reform of the NNPC, the oil & gas industry’s regulatory bodies, the control of the scale of oil theft, or the award of discretionary PSCs and progress on the consideration of the Petroleum Bill to reform the legislative regime for the industry are the key matters which Nigeria’s new President, Muhammadu Buhari must address and good governance is key. The renegotiation of the legacy PSCs as contemplated by the re-balancing clauses is just one aspect; while important, it is modest in the face of these other matters and the need for good governance.

Bryan Gundersen is acknowledged as one of the world’s leading Oil & Gas lawyers by the International Who’s Who of Energy Lawyers and numerous other publications, Bryan brings over 30 years experience in energy law to the Contracts courses

As a course director, Bryan aims to inspire his audience with a combination of compelling case studies, group discussion and challenging exercises. Amidst all his legal successes, he says, “there is nothing quite like being able to help the next generation master the legal complexities of our industry.”

Bryan’s next course is International Oil & Gas Contracts in Lagos, 28-30 November 2016.

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