Volume 43 | Number 3 Summer 2008
The Convergence of Renewed Nationalization, Rising Commodities, and “Americanization” in International Arbitration and the Need for More Rigorous Legal and Procedural Defenses
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III. Concession Agreements, Nationalization, and Its Resurgence
A. From Concessions to Contracts: The Birth and Development of Production Sharing Agreements and National Oil Companies
The evolution of international contracts for the exploitation of natural resources (e.g., timber, fossil fuels, minerals, etc.) and its reflection of the economic, political, cultural, and diplomatic changes that occurred throughout the 20th century, is a topic that has been exhaustively examined by numerous authors.55 In the 19th and early 20th centuries those contracts took the form of “concessions” in which the sovereign transferred actual title to the natural resources over a large area (perhaps even as large as the entire country) for as many as six to seven decades in exchange for a signature bonus and a royalty.56 Under the terms of the concessions the contractor held complete autonomy over operations and could even choose not to undertake efforts to exploit the resource without any consequence.57
However, shifts in world politics following the end of colonialism, coupled with the rise of nationalism and oil wealth, enhanced the bargaining power of nations rich in natural resources and led to more favorable terms to the state or sovereign in such agreements. Whether labeled a “modern concession,” “production sharing agreement,” or “participation agreement,” more recent versions of these international agreements reflect substantial changes from the early 20th century concessions in the resource-bearing nations’ favor. Depending on the circumstances, such changes include: (1) the host nation retaining title and ownership over the resource; (2) the term of the agreement spanning a far shorter period of time (20–40 years); (3) the grant covering smaller territorial areas; (4) specific monetary commitments being made for exploration and development during early operations with all costs carried by the contractor; (5) a state-owned oil company or ministry being assigned to oversee, or participate in operations with, the contractor; and (6) more generous compensation being paid to the host-country through bonuses, graduated royalty and share levels, and taxes on the contractor’s income.58
As part of these negotiations, and in response to rising nationalization, renegotiation requests, and the substantial capital risks involved in these ventures, drafters for the contractors balanced these new, less favorable economic terms with protections for the foreign investor, including choice-of-law clauses to ensure the application of western or international legal principles, mandatory international arbitration clauses before an established arbitral institution such as the ICC, and stabilization clauses.59 In conjunction with the principles set forth in the Libyan arbitrations and the growing number of countries ratifying the New York Convention, these provisions served as a means to mitigate the economic and political risks inherent in such projects. In addition, they served as strong defenses to attempts to renegotiate or terminate contracts through threats of seizure, regulation, taxes, or claims of environmental damage or mismanagement.
By the mid-1970s, the majority of the world’s oil producing countries had established government agencies or ministries and national oil companies60 to manage and operate fields themselves, to implement government energy policies, and to oversee operations by contracting multinational companies.61 This evolution in the sophistication of policy implementation in producing countries has proven critical to defending against claims of environmental damage or mismanagement. These ministries and national oil companies which have gained expertise in the oil industry play an important role under the modern production sharing agreement (“PSA”), farm-out agreements, and service contracts. These agreements generally provide that the relevant national agency or company shall retain oversight of the operations, shall receive reports and work programs and budgets, shall be entitled to inspect any operation or facility, shall receive a copy of all data resulting from the operations, and shall assist and consult with the contractor about operations.62 For example, Turkmenistan’s model production sharing agreement provides, in part, as follows:
11.1 So long as the Exploration Licence and any Production Licences issued to Contractor hereunder remain in force, at least ninety (90) days prior to the beginning of each Calendar Year, Contractor shall prepare and submit to the Management Committee for its review and approval, pursuant to Article 9, a detailed annual Work Programme and Budget, setting forth the Petroleum Operations which Contractor proposes to carry out in the ensuing Calendar Year, and the estimated costs thereof. . . .
. . .
11.3 Each proposed annual Work Programme and Budget shall include, as a minimum, the following:
(a) a detailed description of the work to be performed during the following Calendar Year, proposals as to subcontractors and suppliers necessary for the implementation of such work and a time schedule for performing it; and
(b) a detailed estimate of the expenditure to be incurred in performing the proposed annual Work Programme and a time schedule for the incurrence of such expenditures.
. . .
11.6 Contractor shall conduct quarterly reviews of the annual Work Programme and Budget. . . .
. . .
ARTICLE 12 DISCOVERY, DEVELOPMENT AND PRODUCTION
12.1 . . . As soon as practicable after the completion of the well-testing program (or where no well-testing is to be undertaken), Contractor shall notify Competent Body of its views as to whether: (i) the Discovery is a Commercial Discovery; or (ii) Appraisal is necessary to determine if the Discovery is a Commercial Discovery; or (iii) the Discovery is not a Commercial Discovery and Appraisal is not warranted; or (iv) the Discovery may, together with any other Discovery within the Contract Area, be capable of constituting a Commercial Discovery.
12.2 (a) In the case of paragraph 12.1(ii), Contractor shall, promptly after the technical evaluation of the test results relating to such Discovery has been completed, prepare and submit for review and approval by the Management Committee an Appraisal Work Programme and Budget relevant to such Discovery. . . .
12.3 Within ninety (90) days following completion of an Appraisal Programme, Contractor shall prepare and submit to the Management Committee a detailed Appraisal report on the conduct of the Appraisal Programme and the detailed data of its results, including, but not limited to, the delineation of the areal extent of the Petroleum Reservoir to which the Discovery relates in terms of thickness, lateral extent, estimate of the quantity of recoverable Petroleum therein, along with the conclusion as to whether, in Contractor’s opinion, the Discovery is a Commercial Discovery.
12.4 Within one hundred and eighty (180) days following the notification under paragraph 12.1(i) or following the submission of the Appraisal report under paragraph 12.3 indicating that the Discovery is a Commercial Discovery, Contractor shall prepare and submit to the Management Committee, for review and approval, pursuant to paragraph 9.4, a Development Plan and Budget on the basis of sound engineering and economic principles, in accordance with international good oil-field practice. Such Development Plan shall comprise, but shall not be limited to:
(a) designation of the Development Area;
(b) proposals on spacing, drilling and completion of wells;
(c) proposals for production, storage, transportation and delivery facilities;
(d) proposals for necessary infrastructure developments;
(e) proposals for the employment of citizens of Turkmenistan and use of local material and services, in each case, consistent with the requirements of Articles 21 and 20;
(f) an estimate of the reserves together with wells productivity and production forecasts based on the Maximum Efficient Rate principle;
(g) an estimate of the expenditures necessary to implement the Development Plan; and
(h) an estimate of the time required to complete each phase of the Development Plan.
. . .
12.7 Not less than ninety (90) days prior to the beginning of each Calendar Year following the Date of Commencement of Commercial Production, Contractor shall prepare and furnish to the Management Committee for its review and approval a forecast statement setting forth, by Calendar Quarter, the total quantity of Crude Oil (by quality, grade and gravity) and Natural Gas that Contractor estimates can be produced, saved and transported hereunder from any and all Development Areas during such Calendar Year in accordance with international good oil-field practices. Contractor shall endeavour to produce in each Calendar Year the forecast quantity.63
In sum, both as a matter of national law and as a matter of contract, either the government ministry, the national oil company, or both, may supervise and stand beside the operating company during exploration, development, and production. This legal and contractual arrangement may prove important to defending claims related to the PSA or concession contract brought by the host nation in response to the contractors breach of contract or expropriation claim.
B. Historical Nationalization
Despite some Western perceptions, “nationalization” is not an aberration from a supposed universal move towards capitalism and privatization, but rather it is part of a privatization-nationalization cycle found in many places throughout the world,64 if not the global trend.65 Nationalization of numerous industries became a fixture in the Middle East and Latin America decades ago when many vestiges of colonialism, including long-term concessions to Western European and North American companies, were cast aside, thereby leading to a flurry of international disputes. The reasons underlying nationalization trends and individual expropriations vary widely and include political ideology, foreign relations, decapitalization of the host country, a desire for increased control and independence, market domination, culture, and even religion.66
In the early part of the 20th century, in response to the growing role of fossil fuels in energy production, large international oil companies were founded which then expanded to meet the need for exploration, development, production, refining, transportation, and marketing services.67 Established in the United States, the United Kingdom, and the Netherlands, these companies mirrored the economic, political, and market power of their home countries.68 Major international oil companies began to operate in the Middle East in the 1920s, and by the early 1930s, three European and five American companies controlled most of the oil production in the Middle East.69 According to concessions made during those pre-World War II decades, the producing-country governments could not participate in the development of their oil resources, much less play a role in determining which companies would operate in their territory.70 The governments did not begin to challenge the international oil companies’ control until after World War II.71
Although nationalization in Russia and Mexico actually preceded nationalization in the Middle East, the expropriation of oil field operations in the Middle East represents the first time an entire region moved to nationalize a sector of its economy. As time passed and colonialism ended,72 oil-producing countries began to take the first steps toward nationalization by renegotiating their concessions with multinational oil companies. First, the governments of producing countries bargained for a greater share of profits.73 Next, they moved to increase their roles in the management of the oil companies’ ventures.74 Iran was the first Middle Eastern state to challenge the major oil companies. In what started with a dispute over a greater share of revenues, Iran nationalized the assets of British Petroleum, its sole concessionaire, in 1951.75 Others, such as Kuwait, Saudi Arabia, Libya, and Iraq later followed.
1. A Brief Overview of Early Arbitrations Involving Nationalization
i. Libyan Nationalization Cases
Libya’s nationalization of foreign oil concessions in the early 1970s led to three significant arbitrations: BP Exploration Company (Libya) Ltd. v. Government of Libyan Arab Republic,76 Texaco Overseas Oil Petroleum Co./California Asiatic Oil Co. (TOPCO) v. Government of the Libyan Arab Republic,77 and Libyan American Oil Co. (LIAMCO) v. Government of the Libyan Arab Republic.78 At the time, “[a]rbitrations between private foreign investors and governments [we]re not common events,”79 and the nationalization movement among developing countries, particularly former colonies, had been gaining strength.80 In fact, fueled by its desire to legitimize its nationalization (without compensating foreign investors) and its “reject[ion] of international arbitration as a ‘Western’ (and hence unfair) system,” Libya refused to take part in the BP arbitration, the TOPCO arbitration and the LIAMCO arbitration.81 The Libyan arbitrations, nevertheless, recognized the sanctity of contracts between foreign investors and governments and applied the contractual arbitration clause in the concession agreement to permit the aggrieved investor to seek recourse through international commercial arbitration. Indeed, if one of Libya’s intentions was to weaken arbitration’s role in compensating for expropriation, then its non-participation strategy backfired.
While there are some differences among the arbitral decisions and reasoning in the three Libyan cases (and some criticisms, particularly in the remedies awarded), collectively they established several important legal principles that remain valid today and that have encouraged wider acceptance of arbitration clauses in international relations. First, in each of the three arbitrations, the arbitrator confirmed that he had jurisdiction to decide issues related to Libya’s repudiation of the concession contract.82 Second, the TOPCO and LIAMCO arbitrators analyzed the concession agreement at issue and concluded that it was international in character and thus international legal principles applied to the contract, including the doctrine of pacta sunt servanda:
The state as a sovereign entity possesses the power to grant rights and bind itself to agreed terms. To permit a state to use its sovereignty to disregard commitments that it freely undertook through the exercise of that very sovereignty would be anomalous. Such a result would undermine and destroy the legal framework of the international order.83
Accordingly, each arbitrator concluded that Libya had illegally breached its obligations under the concession contracts and rejected the potential arguments justifying such a breach, including sovereignty concepts, administrative contract theory, and the theory of changed circumstances.84
Understanding the context of the Libyan awards is critical to recognizing their importance. In the 1970s, developing nations had been seeking ways to loosen the rules on expropriation, culminating in the UN General Assembly’s adoption of the Charter of Economic Rights and Duties of States.85 Among other provisions, Article 2 of this charter provides that “every State has and shall freely exercise full and permanent sovereignty, including possession, use and disposal, over all of its wealth, natural resources and economic activities.”86 Indeed, some at the time believed that the adoption of this charter would revive the “Calvo” doctrine, under which the expropriating nation sets the level of compensation for the aggrieved investor.87 Developed countries whose corporate citizens invested in developing countries responded to this threat by taking several steps to safeguard those investments. For example, they sought to conclude bilateral investment treaties requiring international arbitration, they provided guarantees for their citizens’ investments abroad, and they threatened retaliation against expropriating countries.88 In this context, the Libyan arbitration awards can be correctly viewed as another response to the threat to international commerce and investment caused by the nationalization trend.
The response by the developed countries (along with the threat of diminished economic investment) was so strong and so powerful that it led some in the developing world to accept international arbitration with more countries, to ratify the New York Convention, to enact national arbitration laws, and to establish arbitration centers as alternatives to those in developed states.89
ii. Iran-United States Claims Tribunal
The Iran-United States Claims Tribunal stands as a landmark arbitral and diplomatic achievement, as well as one of the gateways for American and Islamic acceptance of international arbitration in the wake of an international crisis.90 In 1979, revolution erupted in Iran, resulting in the overthrow of the Shah of Iran, Mohammad Reza Pahlavi, and in the Iran Hostage Crisis, in which the United States Embassy in Tehran was seized and 66 embassy employees were held hostage for 444 days. In response, the United States employed diplomatic strategies, military means, and economic sanctions (including the freezing of $8 billion in Iranian funds on deposit in the United States) to pressure the Iranian government to return the hostages.
The Iran Hostage Crisis ended when Iran and the United States agreed to the Algiers Declarations, with arbitration as a key component to the accord.91 Under the Algiers Declarations, all legal proceedings in United States courts against Iran would be terminated and all future litigation prohibited in lieu of binding arbitration. The Iran-United States Claims Tribunal became, as the parties intended, a self-contained, internal process to resolve disputes arising from Iran’s revolution.92 The Tribunal’s first meeting was held in the Peace Palace in The Hague on July 1, 1981, later moving to its own facility in The Hague in April 1982. It began conducting arbitrations in accordance with the UNCITRAL Arbitration Rules, subject to some modifications.93 Over the past 26 years, the Iran-United States Claims Tribunal has issued 600 awards, including 83 interlocutory and interim awards, published 133 decisions, and resolved approximately 4,000 claims.94
The Iran-United States Claims Tribunal’s impact on international arbitration practice is significant. First, it reinforced arbitration’s role in the resolution of an international crisis and in creating a forum to decide investor-state and international commercial arbitration claims. Second, the Iran-United States Claims Tribunal’s publication of its awards has provided an invaluable resource for the arbitration community, especially in the investor-state arena. Numerous articles95 and texts96 have been written on the tribunal’s work, and its decisions have become useful authority for international arbitration.97 Finally, it has served as a means for American and Iranian parties and counsel to substantially participate in and gain expertise in arbitral practice (in contrast to the Libyans, who refused to participate in arbitration less than a decade before the Iran Hostage Crisis).
Despite the growth of international investment and the adoption of many trade and investment agreements, as well as further acceptance of international accords on arbitration during the 1990s, the dramatic rise in commodity prices since the turn of the millennium has provided renewed vigor for nationalization—both as a purely economic matter and as a political device.98 Nationalization can take many different forms.99 On one extreme lies outright seizure by the state of a private venture or asset; on the other lies “creeping” or indirect expropriation in which the state uses its authority to regulate via taxes, access, and changes in the law to effect an ultimate relinquishment in favor of the state.100 Indeed, unlike the disputes in the 1970s and 1980s which focused on direct expropriation and the standard of compensation,101 current international investment disputes are expected to turn on whether a state’s regulation constitutes expropriation or a bona fide, nondiscriminatory exercise of sovereign rights.102 This renewed wave of nationalization—following the explosion of international investment during the 1990s—has thus far been led by Latin American countries.
C. Nationalization in Latin America103
Today, nationalization is the trend in Latin America, where the presidents of Venezuela, Bolivia, and Ecuador have championed it as a potential economic boon and a cultural prerogative.104 Buoyed by rising oil prices,105 Venezuela’s President, Hugo Chavez, has led Latin America’s nationalization movement. In the 1990s, Venezuela opened its oil industry to private investment, resulting in the creation of thirty-two operating service agreements with twenty-two foreign oil companies. Under these contracts, foreign companies managed the oil fields while the state-owned oil company, PDVSA, purchased the produced oil at a price fixed to market rates. PDVSA also had the option to purchase minority stakes in projects and held shares in four “strategic associations” that produced heavy crude oil from the Orinoco Belt.106
When the rise in oil prices began in 2004, Venezuela began to take action against foreign investors. In what proved to be the first of many steps in this direction, Venezuela initially raised royalties on the four heavy crude oil ventures from 1 to 16 percent. In 2005, Venezuela’s tax agency notified twenty-two companies that significant back taxes were owed, forcing some companies to pay millions of dollars to settle those tax claims. Moreover, beginning in 2005, Venezuela issued decrees imposing majority state control over its oil fields,107 thus requiring that companies with operating contracts grant PDVSA a majority stake in their projects.108 Many companies, such as Chevron, Total, BP, and Statoil, acquiesced to the demand; others (including ExxonMobil and ConocoPhillips) refused.109 Finally, in 2006, Venezuela announced that additional “extraction” taxes would be levied on foreign oil companies and placed some properties under government control.110
The surge of nationalization and resistance to foreign investment spread beyond Venezuela’s borders to other Latin American countries. On May 1, 2006, Bolivian President Evo Morales carried out one of his campaign promises on the 100th day of his new administration when he announced the nationalization of Bolivian hydrocarbon assets,111 thereby effectively seizing the interests of twenty-six foreign oil and gas companies that held contracts with Bolivia. President Morales issued an order giving foreign oil and gas companies six months to comply with all governmental demands (e.g., all foreign energy-firms were required to sign new contracts giving majority ownership to the state-owned company, Yacimientos Petroliferos Fiscales Bolvianos, to agree to higher taxes, and to dedicate as much as 82 percent of revenues to the state) or face eviction by force.112 Finally, on May 2, 2007, Bolivia cemented the perception that nationalization had taken control when it announced its denunciation of ICSID, which became effective on November 3, 2007.113
Also in May 2006, the same month as the nationalization of Bolivia’s hydrocarbon assets, Ecuador terminated its contract with Occidental Petroleum Company for the operation of Block 15’s oil and gas fields, and the state oil company seized control of the fields.114 This move came only two months after the Ecuadorian legislature amended the Hydrocarbon Laws to require foreign oil companies to pay the country 50 percent of all revenues from production above a benchmarked price—unilaterally changing the economic terms of the contracts to give the government a larger profit (and reducing the contracting companies’ benefit by approximately half)—and after a new leftist leader, Rafael Correa, was elected, having pledged to renegotiate contracts with foreign investors to ensure that Ecuador obtains a greater share of energy revenues.115
In late 2007, an ICSID tribunal ordered Ecuador to cease all domestic legal actions, including criminal proceedings, against City Oriente (a Panamanian oil company) regarding a disputed $28 million in royalties.116 Following Bolivia’s example, Ecuador notified ICSID that, pursuant to Article 25(4) of the ICSID Convention, Ecuador was withdrawing its consent to ICSID arbitration of disputes pertaining to foreign investments in natural resources, including oil, gas, and minerals.117
The debate on whether aggressive resource nationalization will spread beyond Venezuela, Bolivia, and Ecuador continues, although President Chavez’s socialist vision appears to be spreading to other countries and other leaders in the region including Argentina, Brazil, and Chile.118