Energy Law: Balancing Stabilization Clause with Human Rights and Sustainable Development of Host Communities!

An abridged version appeared on the Association of International Petroleum Negotiators (AIPN) discussion Board on LinkedIn).

“The responsibility to respect human rights is a global standard of expected conduct for all business enterprises wherever they operate. It exists independently of States’ abilities and/or willingness to fulfil their own human rights obligations and does not diminish those obligations. And it exists over and above compliance with national laws and regulations protecting human rights.” - Guiding Principles on Business and Human Rights: Implementing the United Nations “Protect, Respect and Remedy” Framework, John Ruggie. March 21, 2011.

Background

March 2011, I participated in a semester-long seminar on the Emerging International Framework for the Sustainable Development of Human and Natural Resources in Mineral Resources Rich Countries of the world. Towards the end of the workshop, one of the guest lecturers, during his presentation, told us a harrowing story of an agrarian community in Sub-Sahara Africa (name of the country withheld by this author) that was involuntarily relocated to a newly built settlement to provide land for a foreign mining company.

According to the speaker, the mining company compensated the dislocated villagers handsomely with a reasonable bank account and new homes – homes not roomier than they had before. Sadly, within a few years, most of the villagers depleted their savings and were left with nothing.

Only a few male adults trained by the mining company were offered jobs at the mine. It was a hopeless sight to behold; a once agrarian community, transformed into a mini town in the middle of nowhere, now in total want of essential means of livelihood.

Joblessness and social vices reign supreme and poverty enveloped the land. The sight of goats and cows rummaging the community shore and beyond - scavenging unhinged for nourishment - now flourishes only in the imagination of the settlers. And a much cherished communal lifestyle turned folklore told in tears and grief.

As the lecture continued and the video beamed pictures of helplessness and deprivations, it came to a point where I could no longer subdue the revulsion ravaging my inner soul.  I raised my hand and interrupted the lecture. I politely asked the gentleman, if, in addition to the bank account and brand new homes, they set aside new land at the newly built settlement for a continuation of their agrarian lifestyle given the fact that they were primarily into farming and husbandry at their ancestral homes before the forced relocation. He stared at me and didn’t vouch for a response instantly. It was a long pulse, to say the least.

The gentleman walked toward me with a steady focus, and said: 'If I have to do it again, that would be my first priority.' ‘But to answer your question, we did not do that.’ He went further to add: “The point you just raised is the situation all over the world, where, in pursuit of the development of natural resources, communities have been evacuated and involuntarily resettled at a new location.”

In the instant case, what we saw was that a substantial part of the settlers’ heritage and their inherent identity were permanently erased following relocation. 

Also, the native landowners were forced into a world of an endless new beginning; languishing in hopelessness, where things may never be the same again or change for the better. An agrarian community that used to be self-sufficient in food production is now a beggar community in a new world that they never bargain to beat. It was a hopeless situation through and through.

In this essay, we will, first, give a historical highlight of some of the decided cases that overwhelmingly benefited multinational oil companies, to be followed by the intervention of the United Nations (UN), imposing new responsibilities on foreign investors and asserting sovereign rights on behalf of host nations, and finally, we will touch on emerging trends that lay emphasis on “social license” and integrated contract.

Stabilization Clause: Cases and Places

Coming from a developing country that is very rich in natural mineral resources and where there is a never-ending conflict between IOCs and the local communities on one hand, and between the local communities and the central government on the other, my take on stabilization clause is transcendental of taxation methodology, and certainly, broader than most of the views expressed here. Based on empirical evidence surrounding the exploitation and exploration of natural resources in my country, and in most developing countries, a stabilization clause, no matter how well written, does not - standing alone - guarantee a continuous revenue stream for IOCs, nor provide adequate stability for investment in a host state/nation perpetually.  I will explain that in detail later. But first...

Stabilization clause refers to the provisions in a private contract between investors and the host nation that prohibits the host nation from changing the terms of the agreements,  for a specific period,  or for the duration of the project. The fundamental goal of the stabilization clause is to mitigate risks associated with sudden changes in the regulatory regime and to forestall outright regulatory appropriation (nationalization) by the host nation.

There are three basic types of stabilization clauses.

1. Freezing Clauses – As the name implies, aimed at freezing the laws that govern the contract from the day it was formed and throughout the project.
2. Economic Equilibrium Clauses – Cover payment of compensation in the event of changes in the existing contract, or applicable laws.
3. Hybrid Clauses – Safeguard against all changes in legislation, by requiring compensation or adjustments to the deal, including exemption from new laws.

Regulatory changes that most often catalyze protests on the part of foreign investors are the Introduction of a new tax regime and an increase in tax and royalty rates. A good example was the protracted dispute between Anadarko Petroleum and Sonatrach (Algeria State Oil Company) over the application of the 2005 Algeria Hydrocarbon Law, modified in 2006, which empowers the government to tax oil windfall profits. In 2007, the Algerian government introduced a new tax on exceptional profits made under existing contracts while Brent Crude prices exceeded $30 /bb/.  In 2011, Anadarko went to arbitration, arguing that the application was a violation of the PSA structured between it and the host nation.

Historically, some regulatory expropriations may be due to political changes or ideological shifts in the economic system. In the case of Libya American Oil Company (ARAMCO) v. Government of the Libyan Arab Republic, the stabilization clause was upheld according to the terms of the concession right granted under the Libya Petroleum Law No 251955. In the words of Arbitrator Mahmassani: “It is widely accepted in international law and practice that an arbitration clause survives the unilateral termination by the State of the contract in which it is inserted and continues in force even after that termination. This is a logical consequence of the interpretation of the intention of the contracting parties, and appears to be one of the basic conditions for creating a favourable climate for foreign investment.”

In Lena Goldfields, Ltd v. U.S.S.R 1930, the Concession Agreement entered into in 1925, granted the company exclusive rights of exploration and mining for 50 years. Adding to that, the Soviet government agreed not to make any alteration to the agreement by order or decree without Lena’s consent. However, in 1929 the Soviet government changed the entire economy and embraced the communist system under the Five-Year-Plan. The government became the only customer and supplier. Lena took the government to arbitration, arguing that the Government had made it impossible for the Company to perform its obligations and to enjoy its rights under the concession agreement. The tribunal held for Lena on breach of contract charges and on restitution for the full present value of its properties – unjust enrichment and for the confiscation of Lena’s properties.

However, some regulatory changes are non-related to a version of the Western political system or motivated by the need to benefit from profits windfall as we saw in Algerian (Sonatrach) v. Anadarko Petroleum. In Saudi Arabia v. Arabian American Oil Co, the issue here was simply not ideologically driven. Instead, it was a development influenced principally by an investment diversification drive - the creation of new markets and new trading partners.

The Saudi authority simply reneged on the existing agreement it had with Arabian American Oil Co that prohibits Saudi Arabia from dealing with other investors. In the ensuing suit, the tribunal held among other things, that the “stabilization” clause in the 1935 concession, by which Saudi Arabia had undertaken not to modify or restrict ARAMCO’s right, was binding on the host state. In other words, the Saudi authority is prohibited from dealing with different partners, except Arabian American Oil Co.

In sum, what is at stake as revealed in all the cases decided above is the interest of foreign investors in having a favorable investment climate in the host nation throughout the investment. Disappointingly, these protective mechanisms in the agreement are unconscionable, and lopsidedly structured to circumscribe the lawmaking power inherent in the sovereignty of host nations. The concessionaire agreement between the National Transition Government of Liberia and Mattel Steel Holdings AG (a Mining company) calls into question the sincerity of some Western multinationals in their dealings with developing countries.

Part of the original agreement reads, courtesy of Global Witness: “Any modifications that could be made in the future to the law in effect on the effective date shall not apply to the concessionaire and its associates without their prior written consent, but the concessionaire and its associated may at any time elect to be governed by the legal and regulatory provisions resulting from changes made at any time in the law as in effect on the effective date. In the event of any conflict between this Agreement and the rights, obligations, and duties of a Party under this agreement, and any other law, including administrative rules and procedures and matters relating to procedures, and applicable international law, then this agreement shall govern the rights, obligations, and duties of the parties”. 

The agreement was subsequently modified following a concerted global outrage and protest, especially from Global Witness, some MBA students from Columbia University in New York City, and concerned Liberians at home and abroad. There are numerous instances like this where some countries resorted to legislative expropriation (nationalization) rather than litigate or renegotiate the unconscionable agreement.

In hindsight, it is no longer fashionable for multinationals to take undue advantage of their financial strength and superior bargaining power to undermine human rights, environmental concerns of local communities as well as the sovereign status of a given nation-state. Therefore, we suggest that stakeholders dilute stabilization clauses with ecological and human rights exceptions while providing foreign investors and IOCs with adequate leeway to negotiate if the promulgation of new laws or new tax regimes adversely impacts the substantive agreement.

Below, are two stabilization clauses of the nation-state of Angola and the People's Republic of China that are seemingly in sync with the position of this paper concerning balancing the interests of IOCs against those of the host nation and communities. Also, they are in accord with the 1962 UN declaration as well as modern trends in natural resources agreements, reproduced here courtesy of International Petroleum Transactions – Ernest E. Smith. 

1. “If any change in the provisions of any law, decree, or regulation in force in the Republic of Angola occurs after the signing of this Agreement which adversely affects the obligations, rights, and benefits hereunder, then the Parties shall agree on amendments to the Agreement to be submitted to the competent authorities for approval, to restore such rights, obligations, and forecasted benefits”. 
2. “If a material change occurs to the Contractor’s economic benefits after this contract becomes effective [the 1990s] due to the promulgation of new laws, decrees, rules, and regulations, made by the Government of the People’s Republic of China, the Parties shall consult promptly and make necessary revisions and adjustments to the relevant provisions of the Contract to maintain the Contractor’s normal economic benefits hereunder”. 

Statehood, Human Rights Protection, and Integrated Contract

Statehood demands of every sovereign nation, Nigeria inclusive, the right to develop a fundamental framework for natural resources conservation, to ensure sustainable use for and on behalf of the governed, and specifically, for and on behalf of the local or host communities and the unborn generations in the natural resource-rich regions.

Most importantly, host governments shouldn't abdicate their sovereign rights to enact new laws or have their rights to make new laws preempted. So, the power to modify the existing tax regime should withstand stabilization clauses in every investment agreement. Of significant relevance here is the United Nations General Assembly resolution 1803 (XVII) of 14 December 1962, "Permanent sovereignty over natural resources." Parts of that declaration read:

The right of peoples and nations to permanent sovereignty over their natural wealth and resources must be exercised in the interest of their national development and of the well-being of the people of the State concerned.

The exploration, development, and disposition of such resources, as well as the import of the foreign capital required for these purposes, should be in conformity with the rules and conditions which the peoples and nations freely consider to be necessary or desirable concerning the authorization, restriction or prohibition of such activities.

In cases where authorization is granted, the capital and the earnings on that capital shall be governed by the terms thereof, by the national legislation in force and by international law. The profits derived must be shared in the proportions freely agreed upon, in each case, between the investors and the recipient State, due care being taken to ensure that there is no impairment, for any reason, of that State's sovereignty over its natural wealth and resources.

From the preceding, it is quite apparent that sovereign rights and the protection of human rights in the host state are as necessary as the protection of foreign investments. In hindsight, where human rights and environmental protection are missing in current contracts, or where compliance with a given agreement imperils the host state’s ability to legislate on human rights protection and the environment, the commitment, most often, becomes operationally problematic. Therefore, investors and the government of the host state must ensure that both competing interests are adequately protected.

That fundamental framework involves the integration of human rights and human resources development concerns within the body of the various international investment agreements negotiated between host Nations and local and foreign investors. It requires balancing the investment interests of the investors against those of the host nations, without undermining the environmental impacts associated with the activities of the investors, as well as the human rights and sustainable development of the host communities. That is the current trend in the development of mineral resources around the World - balancing the investment interests of foreign multinationals with the interests and expectations of the host communities within the body of the original contract or agreement. Not being treated as an ancillary or a collateral issue.

It requires the establishment of Land Reclamation Funds or Water Restoration Funds, created at the inception of the exploration agreement to be funded by the Federal Government, IOCs, and LOCs with a certain percentage of estimated yearly earnings agreed upon by the parties. The contracting parties must deposit the funds in an escrow account during each calendar year, specifically to offset environmental cleanup (Gulf of New Mexico), oil spillage as was the case in Bonga Field, the Ogoni land, and most recently, the Kogi minefield. That is an emerging trend globally.

It also involves land reclamation and decommissioning costs whenever the need arises or whenever the investor ceases operations. (Shell departure, for example). The land reclamation funds, the escrow account, as well as water restoration obligations are essential and mandatory components of an integrated contract. It means transforming the water (river) or the land to its pristine natural state before exploratory activities. 

It requires honest and transparent negotiations between the government, IOCs, and the local communities where natural resources are located. IOCs should endeavour to engage and interact socially and economically with the local people regularly by buying local produce and attending community affairs, and cultural festivals. It is called a social license, which is more important than any PSA.

Besides, the divide and rule system (setting up one community against another or one interest group against another as was the case in the trial and execution of Ken Saro-Wiwa) is counterproductive and should be avoided by the stakeholders, the central government, and the IOCs.

In Nigeria, environmental compliance is not given a commensurate premium despite the enormity of the inherent hazards in the industry and is hardly regulated. This phenomenon is least connected with the want of applicable laws or regulations in the sector, but due to logistics-related problems and the lackadaisical approach to regulatory mechanisms by those vested with the authority to regulate. As expected, oil companies often take advantage of the vacuum in the regulatory regime and laugh all the way to the bank with impunity. Consequently, leaving the peasants and aquatic farmers (the owners of the land) who depend solely on ecological resources as a means of sustenance in a dire state of hopelessness.

Environmental abuse and unbridled human rights violations compelled the UN to initiate Ruggie’s Study and Report, which has come to define the new global approach to the exploitation of natural resources. It is anchored on Protect, Respect, and Remedy. These obligations – human rights protection, environmental and regulatory compliance, grievance mechanisms, and prompt resolution of disputes - are independent of and separated from the ability or willingness of the host nation to provide the same to its people, specifically, to the communities in and around the location of the investment. 

Social License and Dispute Resolution

Based on empirical evidence surrounding the exploitation/exploration of natural resources in Nigeria and in most developing countries of the world, the stabilization clause, no matter how well written or structured, does not - standing alone - guarantee a continuous revenue stream for IOCs or domestic investors. 

Presently, it cost Shell and the Nigerian Federal Government much more to provide security for expatriate workers and facilities in the Niger Delta in comparison to what other oil companies, similarly situated, pay to maintain production at the same capacity elsewhere.  The facts are whenever Shell declares force majeure; both Shell and the federal government suffer substantial financial setbacks, running into millions of dollars in revenue, royalties, and taxes. When those are factors into the huge security budget and the replacement cost resulting from recurring expenses associated with burning and looting, you would have had much more than enough to finance the demands of the local communities before grievances escalate out of control into kidnapping and vandalism.

According to the International Finance Corporation (IFC), “Before disputes escalate to the settlement at an international level, companies must ensure that they have in place adequate mechanisms for dispute resolution between its stakeholders and the communities. A grievance mechanism should provide a way for the communities to hold the company accountable, to be sure it takes community inputs seriously, deal with them through a clear and transparent process, follow through with actions, and communicate with the community.”

Given the restive situation in the Niger Delta, it is reasonable to conclude that stabilization clauses standing alone, cannot guarantee the stability that investors desire in an economy. Presently, Anglo-Dutch Shell BP and AGIP have been downsizing operations in Nigeria, because of the upsurge in vandalism, kidnapping, and the indiscriminate destruction of pipelines and construction facilities by the militants in some parts of the Niger Delta.

In fact, the Nigerian government did not introduce a new tax regime or change the dynamics of the regulatory framework governing any PSA. The civil society created an unpleasant investment climate that made the performance at the projected level commercially impracticable; thus, making it difficult comparatively for Shell to remain in operation as it was about 15 years ago. So, a stabilization clause as an investment protection mechanism is an illusion. 

There must be in place, mechanisms for resolving and promptly so, of disputes and disagreements between IOCs and local communities before they escalate to mass protests.

Similarly, stakeholders should take cognizance of the fact that investment treaties and stabilization clauses do not provide the kind of stability that developing some forms of relationship (social license) with the community offers. Susan Joyce put it better, "the governments define the scope of legal compliance, but the broader scope of the responsibility to respect is defined by social expectations – as part of the company’s social license to operate.”

Moving Forward!

The demand for the integration of human rights, human resources development, and sustainable development within the framework of every investment agreement in the extractive sector, is not just an an intellectual exercise. It is real and achievable if diligently pursued. Investment Treaties and Stabilization Clauses do not provide the kind of stability that developing some forms of relationship (social license) with the community offers.

Based on indisputable facts, social license trumps stabilization clauses as far as investment stability goes on foreign soil. More emphasis should be on the office of the Director of Public Affairs – an office with a decisive and social mandate, with the ability to project a positive social image of IOCs before the local communities.

Therefore, all the super Lawyers, Accountants, and Geologists holding briefs for some of these multinationals having investments or contemplating investments in the Middle Belt and North East or in developing countries should be cognizant of these developing trends, when structuring natural resources agreements. In other words, they should be mindful of the fact that the stabilization clause has its limitations.

The earlier nation-states and foreign investors embrace and acknowledge the interests and concerns of Indigenous people and inculcate those concerns into their final investment agreements, the closer we are to peace and sustainable human development in the mineral-producing areas anywhere in the World. Nothing enriches shareholders' values more than sustainable income. But first, there must be peace and tranquillity at the job site.

It is our firm belief that any IOC that values life, liberty, freedom, and fundamental human rights of others, especially of people living in and around mines and rigs should not prevaricate on these measures.

The United Nations has over the years developed numerous papers and articles on this very issue of integration of human rights and investors’ interests in natural resources agreements with host nations to ensure sustainable peace and development. The one that I find most revealing is the Rio Declaration of 1992. Four of the articles are reproduced below.

• “Human beings are at the centre of concerns for sustainable development. They are entitled to a healthy and productive life in harmony with nature.”
• “The right to development must be fulfilled to equitably meet developmental and environmental needs of present and future generations.”
• “To achieve sustainable development, environmental protection shall constitute an integral part of the development process and cannot be considered in isolation from it.”
• “Indigenous people and their communities and other local communities have a vital role in environmental management and development because of their knowledge and traditional practices. States should recognize and duly support their identity, culture, and interests and enable their effective participation in the achievement of sustainable development.” UN RIO DECLARATION: Principles 1, 3, 4, & 24

Therefore, we firmly hold that the number one problem facing multinationals in the extractive sector, especially in developing countries, Niger Delta, in particular, is a failure of corporate social responsibility and the greed and betrayal of the representatives of the central government. Also, the host nation should hold IOCs liable for any financial loss resulting from the declaration of force majeure unconnected with natural disasters, or unforeseeable catastrophic occurrences. In other words, you cannot declare force majeure over foreseeable and preventable grievances. It is that simple. Also, we firmly believe that the health and environmental hazards prevalent in the oil-producing areas and Niger Delta, in particular, are preventable, and the economic deprivations and financial losses inherent in oil spillage and pollution are compensable. Host nations, as well as host communities, working through the proper channel, should demand punitive damages where catastrophic occurrences are foreseeable, egregious, and preventable. I beg to move. 

Thank you and God Bless.

Mr. Alex Aidaghese. (LL.M)

[i] Susan Joyce: “Human Rights and the Extractive Industries: the Ruggie Framework and Human Rights Impact Assessments.

[ii] IFC: International Finance Corporation. Good practice Note: Addressing Grievances from Project-Affected Communities. Guidance for projects and companies on designing grievance mechanisms.

[iii] Susan Joyce: “Human Rights and the Extractive Industries: the Ruggie Framework and Human Rights Impact Assessment.