Resource Nationalism: Managing the Risk

MITIGATING THE RISK

It is imperative when looking to make an investment in producer states, and before the investment is made, that serious thought and consideration is given to how to avoid and/or mitigate the risks to that investment of resource nationalism.

Overview

The main means through which mitigation may be achieved are as follows:

(1)  Contractual provisions.

(2)  Bilateral investment treaties (commonly referred to as BITs).

(3)  Political risk insurance.

Contractual provisions

Stabilisation clauses can be included in agreements with producer states.  Such clauses seek to preserve the legal and economic deal agreed upon between the producer state and the investor at the outset, notwithstanding changes to the law of the producer state.

There are two main types of stabilisation clause:

(a)   A freezing clause which requires the producer state not to make any changes to the law in place at the time the agreement was entered into which would affect the contract in question. New legislation is stated in the contract with the producer state not to apply to the contract.

(b)  An economic equilibrium clause which provides for an adjustment of contractual terms to reflect the changes to the law of the producer state. In other words, rather than changes to the law not applying to the relevant contract, there will be a clause stating that the parties will seek to renegotiate the contract to restore the investor’s position to what it would have been before the law changed, alternatively for the state to pay compensation.

Do Stabilisation clauses work?

Stabilisation clauses can be an important tool and provide useful leverage. The downside is that investors may need to seek recourse to the national courts to enforce them. This is where issues may arise. If the legal system of the producer state is inefficient, corrupt or lacks independence from the government, the effectiveness of stabilisation clauses is likely to be limited.

BITs

What is a BIT?

One of the most important tools available to foreign investors is the BIT. A BIT is an international agreement between two states which sets out the terms and conditions for private investment by the nationals / companies of one state in another state, which is typically a developing economy.

BITs are often described as a form of self-insurance for foreign investors, and are particularly important for oil companies who are involved in high value long-term projects in high risk countries.

What protection does a BIT give?  In broad terms, a BIT gives rise to certain rights to the foreign investor not to have its assets expropriated or to be treated unfairly. All BITs are different and must be read and interpreted individually. Some BITs provide greater protection than others.

What are the key features of a BIT?

• Protection against expropriation of the investor’s property without compensation.
• Free transfer of funds out of the investment and producer state.
• Requirement for the producer state to adopt all reasonable measures to physically protect investments from attack.
• Requirement that the producer state treats investors from one jurisdiction with no less favourable treatment than investors from any other jurisdiction.
• Right to procedural fairness and freedom from harassment.

Which African countries have BITs with the United Kingdom?

The United Kingdom has entered into in excess of 100 BITs worldwide, including with the following African countries:

How are disputes under a BIT determined?

The BIT provides for the investor to enforce its treaty rights against the producer state directly, without the need for the rights to be set out in the contract in question. Provided there is a BIT in place between the state of incorporation of the investor and the state where they are conducting their business, the foreign investor will be able to take its claim to arbitration.

Typically, the determination of such claims of breach of treaty rights will take place through the International Centre for Settlement of Investment Disputes (“ICSID”) in Washington. ICSID was set up by the World Bank and, consequently, can be a powerful tool where the state in question is likely to be a significant borrower from the World Bank. Refusal to comply with an ICSID award may affect their sovereign risk ratings thereby increasing their borrowing costs.

With an arbitration award it will likely be enforceable under the New York Convention (“Convention”) and therefore the producer state will be required by international law to recognise the award.

Whilst not all of the countries listed above are party to the Convention, those countries are ICSID member states and it is therefore unlikely that they would refuse to enforce an ICSID arbitration award, in most cases at least.

Should the investor have to seek to enforce its award, subject to certain exceptions, the award may be enforced against the producer state’s worldwide assets, including those in the investor’s home state.

Are BITs effective?

BITs can be effective but the time taken for a matter to reach a hearing and be determined can be extremely long. The average time from start to finish of a BIT arbitration is 4 years (not including time taken after obtaining the award to enforce it).

Thus, BITs provide a means of compensation for cases where the relationship between the producing state and the investor has completely broken down but in themselves do not provide a way of seeking swift resolution or redress.

What is significant to note, however, is that the threat of a BIT arbitration can be a powerful weapon to bring a government to the table to negotiate a settlement. Falling foul of the international community and possible consequences of an impact on government borrowings often makes the threat of an ICSID arbitration a situation to be avoided.

Political risk insurance

Typically, political risk insurance policies will cover instances where, for example, the investor’s property has been misappropriated by the producer state but not, for example, where changes to the law in place at the time the investment are made are enacted and result in the investment being less profitable.

In instances of large, long-term natural resources projects in high risk jurisdictions, the cost of political risk insurance is likely to make the overall cost of the investment prohibitively expensive and there is, as with all forms of insurance, the risk that in the event of a claim coverage will be denied owing to issues of causation and applicability of exclusions to coverage.

Most oil and gas companies, certainly the small to mid-cap players, in our experience, do not have this type of cover in place. The cost is simply too prohibitive.

OUR ADVICE

It is important that oil and gas companies looking to invest in Africa take advice, or at least give consideration, to the means of minimising the risks caused by political instability and resource nationalism in the producer state. All 3 of the options referred to above: including specific contractual provisions, checking BIT protection (including whether the interposing of a new company in the group structure, incorporated in a state with strong BIT protection would assist) and the purchase of political risk insurance should be considered

All too often, companies fail to consider this issue at the outset when the momentum is simply in favour of acquiring a licence and getting the deal done. However, they may well pay a costly price down the line. Whilst none of the above solutions are watertight, they nonetheless can provide important leverage (in the case of the first 2 options) and important compensation (in the case of the third) if matters do go wrong.

Anne McMahon
Jane Marsden