Investment cycles and the rule of law in the international oil and gas industry: some reflections on changing investor-state relationships.

Author:Cameron, Peter D.
 
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  1. INTRODUCTION II. THE SEARCH FOR PREDICTABILITY III. TACKLING THE ASYMMETRY OF SPECIALIST KNOWLEDGE IV. MANAGING LONG-TERM CONTRACTS BETWEEN INVESTORS AND STATES A. Ring in the New B. Treaty Protection C. Contract Protection V. CONCLUSIONS I. INTRODUCTION

    The linkage between investment cycles and the Rule of Law in the international oil and gas industry has sometimes aroused comment among international lawyers. (1) It remains as topical a subject today as ever, with a sharp and possibly sustained downturn in investment following on a long period of high commodity prices, sometimes called a 'commodities super-cycle.' The confidence of governments in producing countries and many investors that the benefits of high prices would continue for many years has been punctured by events. Nemesis follows hubris, time and time again. Yet the variety of legal instruments designed to counter or mitigate the effects of these swings of fortune--the investment cycles and the political responses they often trigger --has grown both quantitatively and qualitatively. The diversity of players and the quality of advice has grown too. A convenient method of identifying some of the ways in which the contemporary legal landscape has been adapted to improve the management of hydrocarbon resources and anticipate uncertainty is to compare and contrast it with that of the previous downturn. Indeed, such a method is readily available.

    Among the many achievements of the university of Houston Law center and the Houston Journal of International Law is the lead it took twenty-five years ago to design a kind of Best Practice 101 of Oil and Gas Law (2) and ready it for application abroad. The driver behind this exercise was the opening up to the West of the Russian petroleum-bearing provinces at the end of the so-called Cold War. (3) At the time, the international oil and gas industry was still reeling from the loss of control over Middle East oil and was looking for a new frontier province where abundant supplies of petroleum would be found. (4) There was a perception that the new market-oriented Russia represented an El Dorado of opportunity for investors at a time of low oil prices. (5) Yet, without sound laws, transparency and an emphasis on best practice in resource management, the more reputable investors hesitated to go in. The Houston initiative was designed to balance a high standard of fairness for the resource owners with the kind of guarantees of a stable legal and business environment that large-scale foreign investment requires. (6) The Rule of Law would replace vague 'arrangements' in which the whims of the State were dominant. The wider significance of this initiative is that it was and remains one of the seminal efforts by world-class academics and leading practitioners of law to design a form of shared governance of petroleum activities between a large capital-importing state and international investors.

    In the twenty-fifth anniversary year of this bold academic initiative, the context is once again one of very low oil prices, (7) causing a high degree of uncertainty about what terms of engagement are appropriate for investors to commit to new projects and what governments should be offering them to secure a long-term relationship. (8) I want, therefore, to take the Houston initiative as a starting point for some reflections on how fair and stable cooperation between host governments and investors (we might call this 'shared governance') might now be framed given developments since then.

    As one might expect, there are some issues that the participants in the original project could not have expected to assume the importance they now have and others that have faded into irrelevance. (9) There are also some elements of continuity however. Outside of the United States, the norm then as now is that hydrocarbon resources are owned by the host state; (10) foreign investors need to accommodate themselves to this fact, since they will arrive as guests at their hosts' table, often in a context in which there is a legacy of unhappy contact with the West. How the two sides establish and maintain long-term contractual relationships in an industry characterized by periodic volatility and demands for renegotiation by governments is, and has been, a matter of controversy among scholars and industry experts for decades. (11) In this article I want to focus on two basic themes about this relationship, that were present in the University of Houston Law Center's venture--knowledge asymmetry and the contractual prerequisites of a long-term relationship--and to examine them in the light of events and trends since that time. My guiding assumption is that the spirit of that project remains relevant today, even if some of the problems are new and others have evolved in unexpected ways.

  2. THE SEARCH FOR PREDICTABILITY

    Let me start with a paradox. The past quarter century has seen a robust growth in concerns and actions to counter the effects of climate change and to reduce the impacts of large-scale fossil fuel usage in modern and modernizing economies. (12) At the same time, there has been an unprecedented increase in the number of countries that are seeking and developing fossil fuels and other minerals. Most of this increase has come from low- and middle-income countries that need to accelerate economic growth in the face of a demographic surge and limited alternatives for growth, such as subsistence agriculture or traditional commodity exports. After a long period of high prices, the commodities super-cycle between 2004 and 2011, there are now more countries exploring for and extracting oil, gas and other minerals than at any time in history. Yet much of this growth has occurred in countries with limited institutional capacity and which offer highly volatile environments for investors. This growth has also coincided with a burgeoning literature that emphasizes the risks of reliance on what are sometimes referred to as the 'extractive industries' (EI), which include oil, gas, and mining. Instead of being a path to accelerated economic growth, it warns, such reliance can lead to social dislocation, corruption and economic mismanagement on a large scale: a 'resource curse', rather than a blessing. (13) The authors have no shortage of real-life evidence to muster in support of their broad claims. Indeed, contrary to expectations, a significant feature of natural resource development is that over half of the countries whose economies it has driven are not catching up in development terms. (14)

    In spite of these risks, many governments will surely weigh up their domestic options and conclude that support for extractive activities and engagement with the international energy (and mining) industry holds more prospective benefits than costs. After all, oil, gas, and mineral resource wealth is widespread in developing states where it frequently accounts for a very high share of gross domestic product (GDP), export earnings, government revenues and jobs. (15) Its economic and social transformative potential for any country capable of producing it has long been evident. (16) In a single generation, the conversion of these non-renewable natural resources into other forms of capital can create the kind of wealth and sustainable opportunities that would allow a country to accelerate its transition from poverty to at least middle-income status and for its citizens to enjoy a better quality of life. (17)

    For low-income countries dependent upon aid, a policy shift towards EIs offers the prospect of an economy diversified away from subsistence agriculture, a balanced budget, a reduction in foreign debt, savings for a time when the resources decline (and for times when the market price falls), and an opportunity to develop new industries. For countries emerging from serious conflict or severe economic misfortune, a policy shift towards EIs offers the prospect of a fresh start. It is not surprising then that the number of countries seeking to use oil, gas, and mining resources to make such a transformation in their societies is increasing significantly. (18) There are now no less than eighty-one countries with economies that are driven by these resources, (19) and almost eighty percent of them have below global average levels of per capita income. (20)

    In moving ahead with their plans, such countries will typically seek out and rely upon whatever advice they can to help them make the right decisions about the legal and economic arrangements that they will need to put in place. The same combination of public need, unfamiliarity with international practice, and vulnerability that was present at the inception of the Houston project, and which acted as a trigger to its inception, is present among many of the 'resource-rich' states of today. A key difference is that there are many more of them, both large and small, in every continent on the planet, and that their starting point in many cases is significantly weaker than Russia's was a quarter century ago.

    In response to this potentially unhappy situation, we may note the increased predictability brought about by rule-making in the international energy industry. The present context is more challenging to capital-importing governments than ever before, and yet, in terms of stability, it is more promising for long-term relationships with investors. The body of energy-related transnational law that has been introduced is very large indeed and justifies a brief listing of examples: 1) in the controversial and booming field of international investment law, where thousands of Bilateral Investment Treaties (BITs) have been concluded since the early 1990s, the number of cases before international tribunals concerning energy disputes has been estimated at forty-three percent of the total; (21) 2) a dedicated investment protection treaty called the Energy Charter Treaty (ECT) came into force in 1998, committing...

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