Introduction
As promised, today’s column addresses the final topic in the now long running series (started September 2016) on Guyana’s coming petroleum sector, namely, its fiscal stabilization clause. Such clauses are found in many petroleum agreements/contracts. As promised also, this discussion will be followed with an explication of my proposed Road Map for the spending of the Guyana’s Government Take from projected petroleum revenues.
In an earlier column, (December 9, 2018), I had indicated that, for present purposes, fiscal stabilization “simply refers to the deliberate insertion of a clause in the Production Sharing Agreement (PSA) designed to deal with any future changes in Guyana’s fiscal laws which may occur during the life of the petroleum project.” In that column, I went on to stress, “such clauses are, by intent, aimed at mitigating any risk the Contractor (Exxon and partners) faces, if Guyana’s fiscal law changes to the Contractor’s detriment.” Such detriment, invariably reduces the value of the Contractor’s investment. However, there is also Guyana’s “detriment.”
This task will occupy both today’s and next week’s columns.
The research and analytical literature on this topic is formidable; going back over several decades. Further, this literary output has intensified since the late 1990s, particularly in the fields of economics, politics and law. In preparation for this topic, I have had to cover a substantial body of this literature but two publications stand out. And, both have shaped the form and content of my presentation. These two pieces are: 1) the Oxford Institute of Energy Studies, 2016 survey of 20 developing countries’ experiences with fiscal stabilization clauses, covering the period from the late 1990s; and, 2) T.M. Ramatula’s Master’s thesis in law (LLM), at the University of Pretoria, in 2017.
Risk and unknowns
I consider the consensus view in the literature to be correct as regards the following observation of mine: All kinds of risks, (but especially, legal, political, economic, security, geostrategic, geological uncertainty and environmental degradation), confront both petroleum resource owners (typically Host Governments) and Investors (typically International Companies) in every long-term (decades old) petroleum project. In the face of this dynamic circumstance, stability clauses seek to affect the legal relationship among the parties to the PSA, thereby, offering, on the one hand, risk mitigation for the investor as an incentive to invest; and, on the other hand, because of the huge capital and “skills components” of such projects, such clauses seek to attract investors that are willing to put up the required resources upfront.
However, as I have repeatedly observed in this series, certain well established features of oil and gas industries have indicated consistently that, in every major project, there are both known unknowns (for example: price volatility, global competition and geological uncertainty) and unknown unknowns. These latter could eventuate at any stage of the project. Investors, therefore, need to shield their investments from any “undesired” outcomes of such unknowns.
It is acknowledged in the Oxford Survey that: “The importance of fiscal stability is a popular mantra for the oil and gas industry.” It goes on to observe, however, that, “in reality, it is rarely delivered, as circumstances are constantly changing. Almost every month, countries announce or introduce fiscal changes such as: a new fiscal regime for a new exploration basin an amendment to an existing regime, higher taxes, the introduction of incentives to stimulate late-life investment with closing of tax loopholes, to name but a few.”
Risk mitigation
For several reasons therefore, in any major petroleum project, risk mitigation from both the Investor and Host country’s perspective has to play a major role going forward. It is readily admitted, however, by all analysts that there are numerous known unknowns, which cannot all be mitigated. Why? The answer is basically due to lack of capacity in such dynamic environments. There will always be entirely unexpected outcomes, that is, ‘unknown unknowns.’
From this vantage point, stability clauses are typically put forward as part (albeit an important part) of broader efforts by both Parties to a PSA. These are, therefore, designed to: 1) distribute risks; 2) insure against risks; and 3) shield against risk. For the Investor, the broader approach typically promotes the inclusion of arbitration of disputes and clear prior agreement on the applicable law to be applied in disputes (whether host country law, investor country’s law or international law).
In next week’s column, I’ll share with readers some of the results obtained from the Oxford Institute of Energy Studies Survey. Before then, I note here, today’s literature widely admits that, although stability clauses are theoretically beneficial to both parties, they are apparently far more desired by Investors. One reason for this asymmetry is that the bargaining strength of the Investor in a PSA peaks in the earlier phases of the project, particularly when exploration is taking place, development, well digging and testing are being put in place, and, the pressure of logistics, skills and capital availability are at the highest. At this stage, the Investor seeks to ensure the typical legal clause applies, such as: “the contract (PSA) entered into by both parties, shall not be annulled, amended or modified n any respect except by mutual consent in writing of the parties.” And, further “compensation” for such changes is offered.
However, while the Investor may seek to freeze both parties’ rights and obligations in law, the stark reality is that the Investor cannot vitiate the sovereignty of the State over its national resources.
While, therefore, States may sign agreements with stability clauses, they remain also under a national obligation to secure the nation’s benefits. This obligation pressures States to upgrade and/or revise existing agreements continuously, as experience with them grows.
Contradiction
The above description highlights the major contradiction, which underlines fiscal stabilization clauses like Guyana’s. It is also the source of intense controversy. However, as the Oxford Survey’s results reveal, in practical terms, these do not add up to much for either the Investor, Host State or Analysts participating in the debate. The results can be considered at best, mixed and inconclusive; help and hindrance at the same time.
Furthermore, “the dynamics of what constitutes a ‘fair share’ of the resource rent are fundamentally unstable given the unpredictability of oil and gas prices; unpredictable geological circumstances; and global competition for scarce capital and know how.” (ibid)
Conclusion
Next week, I’ll wrap up this discussion. The focus there will be two-fold; namely, the Survey results on experiences with stability clauses and the legal constructs that constitute the basis for these clauses.
