Although Rockflow is a technical upstream consultancy, a number of our experts spend a significant amount of their time dealing with matters above the ground. Namely, this means working with people – and helping them to navigate disagreement through negotiation, arbitration or litigation.
The technical, commercial and quantum issues at stake are often very serious. We’ve been involved in cases where companies have been at threat of bankruptcy, or where maritime boundaries have needed to be fixed. We’ve even seen situations where countries sent military forces to secure an asset while a dispute was ongoing.
When the stakes are lower, however, our involvement as independent experts can feel like we’re showing up as a non-player at a card game. As we disclosed in our article on unitisation, fairness sometimes demands a psychological game. And if the parties involved will allow us, we can walk around the table, take note of everyone’s cards, understand their deeper drivers, and help to find a fair and desirable resolution based on what we’ve learned.
Why are there so many disputes in oil and gas?
An enormous percentage of international arbitrations, somewhere in the region of 20 to 25 percent, occur in the oil and gas industry.
Why is the proportion this high? Well, partly it’s because oil and gas is everywhere. Thanks to plastic, virtually everything has some degree of petroleum product in it – supermarket packaging, hospital equipment, car paint and lubricants, synthetic clothing materials. It affects our lives in every way.
However, it’s fair to say that, no matter how widespread oil and gas is, it doesn’t equate to 20 to 25 percent of global industry. So why is it the topic of so many international arbitrations?
As we’ll see, there are at least five reasons why very few contracts are placed under more stress than those in the oil and gas industry.
1. The stakes are great and impact multiple parties.
Oil and gas is a high stakes industry. The size of claims are on average, more than 10 times higher than other industries – usually hundreds of millions of dollars, sometimes billions. A single venture can place such a total against your revenue, or against your irrecuperable costs. If arbitration cases can be likened to a card game, it is one with a colossal pot at the centre.
These high stakes ventures often involve two or more companies, all weighing the risk and reward on different scales – and one company’s scale may tilt dramatically one way or the other when circumstances change.
2. Much is invisible when a contract is drawn.
In the oil and gas industry investment decisions are made under huge uncertainty. At the start of a contract, all the risk and uncertainty is ahead of you. When you make exploration commitments of hundreds of millions of dollars, you really don’t know if there is any oil there or not. So to balance that risk, and to reward your effort, the fiscal terms need to provide the potential to provide a reward commensurate with that risk.
Inevitably even with the best technical assurance teams on your side, you can’t account for everything. There are often uncertainties we don’t account for – we don’t know what we don’t know – especially in subsurface.
Later, after acquiring seismic data, you may be disappointed, and not find any prospects worth drilling. Some companies may be tempted to cut their losses and renege on their commitments rather than simply waste money on something they no longer believe can succeed.
However, once you put down table stakes, you may be forced to play the game – even if there is little chance of winning. The government wants that investment – they still want their acreage explored – there is still a chance after all. If you walk away, you will be in breach of contract, and can find yourself in court with a claim against you.
3. Once oil is struck, it becomes politically visible.
On the other hand, you might find a bonanza, and the newspapers are all asking why the government gave away such attractive fiscal terms, demanding the government should revise the contract to give the people their fair share of the success. Contract terms that seemed reasonable before the investor’s cash was gambled can appear unreasonably generous once that oil is no longer the subject of wild speculation and cash is flowing back to the investor and out of the country.
So although the bets have already been placed, the rules of the game might threaten to change . And of course, this great cash cow you have discovered is immovable. If you get into a dispute with the government about retrospective tax rises, or even expropriation, you can’t just move it to another jurisdiction. You are trapped. That’s why companies rely on international arbitration and bilateral investment treaties to give some protection.
The global reality is that only one in ten exploration wells succeed. The risk-reward balance at the start of a venture is always weighted heavily towards risk, but oil and gas companies are often willing to try regardless. By the time that risk is rewarded, a new political party may be in power, and the new government may well be tempted to tear up the agreements of their predecessors. It can simply look like one party is making too much money, even if that’s an inaccurate interpretation of events when you view them as a whole.
4. Contracts last decades, market conditions don’t.
Unlike a card game, the values of the O&G assets involved do not stay idle. What was once an ace in your hand can suddenly become a lossmaker.
Contracts are fixed, and are intended to last for decades not years, but oil and gas prices are incredibly volatile. A contract that appeared to offer a fair return when it was written may later look distinctly unbalanced to one side or the other. If, as we saw in 2022, when the market crisis sent the gas prices rocketing, your producing asset may become much more valuable. Governments may impose price caps or windfall taxes, despite the contracts and treaties they agreed to. It’s natural at times like this for people to try to renegotiate prices and change terms of deals.
On the other hand, in 2022 we saw many companies go bankrupt on the contracts they signed – such as the gas retailers who were trapped in deals selling to consumers at fixed-price long-term contracts, but were buying their supply at spot prices at suddenly inflated wholesale market prices.
Similarly, if there is a sudden drop in oil prices, field developments can flounder and struggle to break even. In 2019, for instance, a price slide led to 42 cases of upstream company bankruptcies in the U.S and Canada, following years of instability that began after a 2015 oil price crash.
Unlike many industries, the oil and gas market is far reaching, interconnected and prices everywhere are vulnerable to the outbreak of war in one location, sanctions in another, and the latest tax environment. Geopolitical conditions are just as much a factor in oil recovery as geological conditions, and these seismic rumblings can almost inevitably trigger disputes over contract terms.
5. New regulations change the context of an agreement
If we can stretch our card game analogy, some changes in the industry are so monumental that they might be likened to the introduction of a fifth suit.
Following the 2015 Paris Agreement, the oil and gas industry has increasingly been the focus of new ESG regulations. But while most regulations of this nature have become law in the last eight years, many existing E&P contracts were originally signed decades ago.
The general legal principle is “Pacta sunt Servanda” – agreements must be kept. But over such long periods of time, that can be difficult to maintain when circumstances change. At the end of the day, a government is sovereign, and they do make changes that companies have to live with.
Fiscal stabilisation clauses have long been used in Petroleum Agreements to protect investors from adverse tax increases. But now, companies are faced with a changing landscape in environmental legislation and international treaties.
Changes in environmental law impose restrictions and costs that were never considered when older contracts were agreed, massively impacting profitability and even viability of upstream investments. If the goalposts change significantly, a once-profitable venture can become lossmaking, without compensation, creating vast potential for legal claims and disputes. The international law is currently grappling with the implications of the radical changes that are currently blowing across the landscape.
Is there any guarantee an oil or gas contract will last?
With so much uncertainty, volatility, and change in the industry, an observer might wonder how any oil and gas contract withstands the test of time. We need the stability of long term contracts in order to govern ventures, enable investments, and share the rewards between companies and governments. But even with the most expertly- and fairly-drawn contracts, we often need to return to the negotiating table to accommodate change.
As our team has discovered, it’s almost always better when oil and gas companies can navigate disagreement without falling into arbitration. When companies disagree over a technical matter, it’s often possible to resolve through further, independent analysis, or Expert Determination. Even if the dispute is primarily due to commercial, political or economic issues, there’s usually a way to proceed that doesn’t involve arbitration. However if you do proceed with arbitration, our team is ready to help.
What type of dispute do you need help with?
Rockflow is home to a number of independent experts, experienced in arbitration and litigation in jurisdictions across Europe, Africa, the Far East, Central Asia and Middle East.
Our team can support you in Expert Determination, and as Technical Expert Witnesses in arbitration, and litigation cases, such as:
- Investor-State disputes
- The division of costs and revenue
- Contract performance and the failure to deliver
- Fraud and misrepresentation of reserves or assets
- Theft and corruption
- Non-payment
- Consortium disagreements
- Disputes over non-consent
- Delay, including no-fault delays and the refusal to pay overrun
- Cancellation of licences
- Decommissioning
- Liability
- Contingent payment determination and valuation
No matter what your situation is, our arbitration experts are practised at enabling companies and governments to achieve reasonable and fair outcomes.
As independent experts without a stake in any one party’s success, we’re able to do more than simply make an impartial judgement call. We’re also able to see the situation from each organisation’s perspective, understand what’s driving them, and find a fair solution in which no one is an overall loser – one in which everyone benefits.
To learn more about how we can assist you, see our arbitration and litigation services or see our thoughts on how disputes differ in the case of unitisation.
