Introduction
Oil and gas exploration and development is characterised by huge capital expenditure, high technological expertise and the ability to manage investment risks. However, most oil rich developing countries lack the resources, technical expertise and capabilities to manage the large investment risks.[1] As a result, international oil companies (IOCs) with sufficient capital, expertise, and technology as well as investment risks capabilities are issued with licenses to explore and develop oil in the oil-rich developing countries.[2]
In states with high political risk and insufficient or incredible investment protection structures, investors (especially private investors) have to make their investment decision based on a pragmatic, unmitigated risk–reward balancing dependent on price, cost and profitability forecasting.[3] Thus, where a State exercises her sovereign power and changes a contract’s economic and/or fiscal implications on the IOC, such changes tend to tip the balance of the relationship substantially in one’s favour to the injury of the other.
This paper will focus on the Judgement of the Court in Attorney General of Rivers State & Ors vs. Attorney General of the Federation and its legal implication on Production Sharing Contracts between the State and the IOCs.
Production Sharing Contract (PSC)
A Production Sharing Contract (PSC) can be defined as any agreement or arrangement made between the Corporation or the holder and any other petroleum exploration and production company or companies for the purpose of exploration and production of oil in the Deep Offshore and Inland Basins.[4]
As the holder of an oil prospecting license, the State party (NNPC) engages the IOC as a contractor for the purpose of carrying out petroleum exploration and production, in other to create a PSC. The discovered and produced petroleum is shared amongst parties in predetermined proportions and ratios.[5] Ownership of petroleum produced and in situ is vested in the State party until the point of ‘production split’ i.e. when the contractor takes her cost oil and share of profit oil, after royalty (oil) or income tax is deducted and paid to the State.[6] The contractor bears all the exploration risks and usually in charge of operations and management of contract area, unless the State party agrees to take up some direct participatory interests in the venture.[7] Generally, if no oil is found the contractor receives no compensation.[8]Depending on agreement between parties, PSCs are usually designed to have a lifespan of 30 years i.e. 10 years for exploration and 20years for production.
PSCs can be viewed as a legal instrument that satisfies both the essential needs of a private investor and State party. It gives the government the outward appearances of sovereignty and power whileguaranteeing an investor’s hard-core requirements (which is essentially economic and profit maximisation).[9]
Deep Offshore and Inland basin Production Sharing Contracts (PSC) Act. CAP D3, LFN 2004
The Deep Offshore and Inland basin Production Sharing Contracts Act (PSC Act) governs the understanding between the Federal Government through NNPC and all new participants in the new inland, deep & ultra deep-water acreages. The Act proundervides for fiscal incentives given to the oil and gas companies operating in the Deep Offshore and Inland Basin areas production sharing contracts between the Nigerian National Petroleum Corporation or other companies holding oil prospecting licenses or oil mining leases.
Section 16 of the Act provides for a periodic review of the review Act and a of the provisions if the price of crude oil exceeds $20 per barrel. The review clause envisages future events and changes that could affect the economic, commercial and fiscal equilibrium of parties as already agreed. However, the Act did not prescribe how it should be done whether by a regulation or by an order.
The Case of A.G Rivers State & Ors. Vs A.G Federation SC 964/2016
In a suit filed by the Attorneys-General of Rivers State, Bayelsa and Akwa Ibom State (Plaintiffs) against the Federation (Defendant) at the Supreme Court of Nigeria. The Plaintiffs asked the Court to determine:
- Whether by virtue of Section 162 (1), (2) and (10) (a-c) of the Constitution under which the States are entitled to a share of the monies accruing to the Federation Account, an implicit or a quasi trust obligation is created that mandatory statutory provisions from which such funds are derived shall be diligently observed and enforced by the Federal Government or its nominee cognate Minister, Organs and or Parastatals ensuring thereby that beneficiary States qua plaintiffs et al are not underpaid/short-changed in real terms, which is due them under the constitution and contract or enabling statute.
- Whether there is a statutory obligation imposed on the federal government pursuant to section 16 (1) of the Deep Offshore and Inland Basin Production Sharing Contracts Act, to adjust the share of the federal government in the additional revenue accruing under the various productions at any time the price of crude oil exceeds $20 per barrel.
- Whether the failure of the Defendant to accordingly adjust the share of the Government of the Federation in the additional revenue accruing under the Production Sharing Contract following the increase of price of crude oil in excess of $20, constitute a breach of section 16.
The Plaintiffs further asked the Court for the following reliefs:
- A Declaration that there is a statutory obligation imposed on the federal government pursuant to section 16 (1) of the Deep Offshore and Inland Basin Production Sharing Contracts Act, to adjust the share of the federal government in the additional revenue accruing under the various productions at any time the price of crude oil exceeds $20 per barrel, to such extent that the contracts shall be economically beneficial to the Government; and a Fortiori the component Federating States.
- A Declaration that the failure of the Defendant to accordingly adjust the share of the Government of the Federation in the additional revenue accruing under the Production Sharing Contract following the increase of price of crude oil in excess of $20, constitute a breach of section 16 and has hereby affected the total revenue accruing to the Federation and consequently (i) the total statutory allocation accruing to the Plaintiffs by virtue of section 162 of the constitution and
- A consequential Order of the Court compelling the Defendant to adjust the share of the Government of the Federation in the additional revenue accruing under the Production Sharing Contract from the respective times the price of crude oil exceeded $20 per barrel in real terms and to calculate in arrears with effect from August 2003 and recover and pay immediately all outstanding statutory allocations due and payable to the Plaintiffs arising from the said adjustments.
However, the apex court in its ruling read by Justice John Inyang Okoro adopted the terms of amicable settlement between the Plaintiffs, and the Defendant as its judgment in the matter as follows:
- That reliefs (a) (b) and (c) above shall be diligently implemented.
- That the Hon. Attorney General of the Federation on behalf of the Defendant working jointly with the Plaintiffs hereby undertake to immediately set up a body and the necessary mechanism for recovery of all lost revenue accruing to the Federation Account arising from, associated with or pertaining to relief (c) above in the past and up till the date of full recovery and accruing in future or an acceptable instalmental payments thereof within ninety (90) days next from the date of execution or its being made judgement of the Court.
iii. That the Solicitors of the Plaintiff and or their nominee professional advisers shall be members of that body and necessary recovery mechanism set up.
- That the cost of recovery shall be netted off and payable from the gross recovered sum from time to time, prior to placement of net recoveries in the Federation Account.
- That the 13% derivation due to the Plaintiffs shall be paid to them upon recovery in accordance with Section 162 of the 1999 Constitution as amended.
The Interplay of the Sanctity of Contracts Principle and the Principle of Permanent Sovereignty over Natural Resources
The principle of sanctity of contract also referred to as pacta sunt servanda is a general principle of customary international law posited as the right or rule that agreements must be carried out.[10] This principle holds in all kinds of agreements whether it is an international agreement between state parties or an agreement between private parties within a municipal legal system or one between a state and a foreign investor.[11] This principle places a duty on the state party under international law to respect contracts it has freely entered into with a foreign party and is of utmost relevance in international investment contracts. This is because it grants the foreign investor a guarantee that the state party, with whom it has entered into an agreement, will live up to its promises as set out in the contract.[12]
The principle of pacta sunt servanda, is limited by certain qualifications. Notably, in Parkerings-Compagniet AS v Lithuania, the arbitral tribunal recognised ‘each State’s undeniable right to exercise its sovereign legislative power’ and enact, modify or cancel laws but also recognised the impact of a stabilisation agreement or clause.[13]
As has been rightly noted by Professor Higgins:
“The problems that arise in balancing the legitimate expectations of a private party, which has invested on the basis of agreements which it expects to continue into the future, and of the legitimate needs of a government to protect the public interest against changed and unforeseen circumstances, is not peculiar to petroleum concessions in the developing world. The United Kingdom experience in the North Sea is witness to the fact that the same pressures operate upon all nations possessing important exploitable natural resources, regardless of their stage of development or their traditional commitment to the sanctity of contracts and the inviolability of international obligations.”[14]
With the adoption of the principle of “Permanent Sovereignty Over Natural Resources” by UN General Assembly Resolutions 523 (VI) of January 1952 and 626 (VII) of 21 December 1952, it appears that in the context of foreign investment agreements “the conflict is not only between the principles of sanctity of the contract and its mutability but also and perhaps more acutely between stability and sovereignty.[15] The principle of permanent sovereignty is recognized as a fundamental principle of contemporary international law. It is extensively invoked by States, both developed and developing,[16]as a protective shield for their various actions taken in the context of their relations with transnational corporations engaged in the exploration and exploitation of natural resources in their territory. The principle has also been invoked as an overriding principle which can be relied upon to invalidate arrangements regarded as incompatible with it, to restructure existing arrangements and to develop new forms of arrangements. In order to be compatible with the principle, a legal arrangement must conform to a certain number of criteria as enunciated in the landmark Resolution 1803 (XVII) of 14 December 1962 by the UN General Assembly, namely:
(1) it must be in the interests of national development and well-being of the people of the State concerned;
(2) it must be in accordance with the national legislation in force;
(3) it must be freely entered into.[17]
At the core of the concept of permanent sovereignty is the inherent and overriding right of a State to control and dispose of natural wealth and resources in its territory for the benefit of its own people. The Judgement of the Apex Court mirrors the principle of permanent sovereignty. In A.G Rivers State & Ors VS A.G Federation, the principle of permanent sovereignty was invoked to claim revision of the Production Sharing Contract, when the prize of crude oil exceeds $20 per barrel, in accordance with the Deep Offshore and Inland Basin Production Sharing Contracts Act. The revision of the contracts following the Judgement of the Apex Court is in the interest of national development and well-being of the people of Nigeria as the Court ordered that the contracts be adjusted so as to be economically beneficial to the Government.
Legal Implication of the Judgment of the Court in A.G Rivers State & Ors. Vs A.G Federation SC 964/2016
The judgement of the Apex Court addresses the issue of profitability under PSC arrangement. Profitability under PSC arrangements is substantially dependent on oil price.[18] The ownership of petroleum under a PSC arrangement by the State party and the IOCs’ rights as a contractor implies that an inefficient contract will erode the benefits derivable by both sides on the long run and increase transaction cost(s). The IOC requires a stable and predictable framework within the lifespan of the contract, while the State party requires flexibility and capacity to meet state objectives and socio-political and economic exigencies. Essentially, States hold on to their inherent right to dispose of their petroleum resources based on their national interests and objectives. They seek maximum flexibility in extracting, refining and selling these resources, in other to make the most of the current market conditions and to be able to adapt to domestic political scenarios.[19] On the other hand, IOCs (who are operating in an exceptionally long-term and capital-intensive industry) desire a reliable, consistent and transparent legal framework, in other to secure the maximum returns and profits on investments.[20]
It cannot be denied that long-term investment agreements are afflicted with an inherent problem difficult to surmount.[21] As Cattan has rightly put it:
“The oil concession is a species of long-term contract which has to reconcile two apparently conflicting needs: stability and evolution. These two needs are, in fact, two interdependent conditions in an oil concession.”[22]
In the context of long-term contracts these two realities, stability and evolution, appear as the two sides of a coin whose balanced interaction is presumed to do justice to the actors in such a relationship. Each actor seeks advantageous situations during the continuation of the relationship; no one wants to lose but to gain and take advantage of a situation whether caused by changes in circumstances or otherwise.
Implication for the State
A change in fiscal terms that alters the IOCs take or share of the net production can imply that if oil and gas prices rise, the IOC will make huge profits without necessarily increasing their investments i.e. no additional wells drilled, no new enhanced recovery projects undertaken or well stimulations and other operational improvements.[23]The price of oil was economically viable to the IOCs and not the State.
The Order of the Supreme Court compelling an adjustment in the share of the Government of the Federation in the additional revenue accruing under the Production Sharing Contract from the respective times the price of crude oil exceeded $20 per barrel in real terms and to calculate in arrears with effect from August 2003 means more revenue for the State.
However, a pertinent question, is, how is the lost revenue to be recovered?
Following the windfall profit derived by the IOCs during the great increase in the price of crude oil, thereby giving them a greater share of revenue than would ordinarily have been conceded,[24] the State may choose to impose windfall profits tax as a measure for higher financial return with the rise in oil prices.[25] It is a gain for the public good as that will reinforce the state’s role in monitoring the sector.
In addition, the lost revenue may be recovered through the increase in royalty and tax rates and the handling of posted prices. The State may choose to adjust its take from profit oil under the PSC. It is speculated that this likely to be the option to be adopted by the State.
A successful execution of the Judgement of the Court will ensure that government take flexes upward with increased profitability, while the IOC gets appropriate share or returns, thus curtailing the loss of revenue to the state in windfall profits.[26]
Implication for the IOCs
It is trite that States as sovereign entities can revise contracts unilaterally. The real issue is not so much whether the host government can change the contractual relationship, but rather what is the result and implication of such regulatory action for the IOCs.[27]
For the IOCs, the revision of the Production Sharing Contract will affect their return on investment. The major objective of businesses is to make reasonable profit and when changed circumstances make the contract unexpectedly onerous to the IOCs, the performance of the contract cannot be expected in good faith or with fairness by the other party. Accordingly, many investors may lose interest and choose to pull their investment out of the country.
However, the IOCs have the option of referring the change in circumstance to the International Arbitral Tribunal (BIT Arbitration) for a well considered award as to their interest.
Conclusion
Oil prices have exceeded $20 per barrel since 2003. Therefore a review of the PSCs in line with Section 16 of the Deep Offshore and Inland basin Production Sharing Contracts Act has long been overdue. The long-term effect of this judgment cannot yet be fathomed, until the implementation of the judgment commences.
FOOTNOTES:
[1] S.Saidu, & H. A. Sadiq, “Production Sharing or Joint Venturing: What Is the Optimum Petroleum Contractual Arrangement for the Exploitation of Nigeria Oil and Gas?” Journal of Business and Management Sciences, vol. 2, no. 2 (2014): 35-44. doi: 10.12691/jbms-2-2-2, available at https://pdfs.semanticscholar.org/9eea/f1d415b4abb51fb7823702134c48a4e7ae58.pdf last accessed (31 October 2018).
[2] D. Johnston, International Petroleum Fiscal System and Production Sharing Contracts, USA: Penn Well. (1994).
[3] T. W. Wälde, ‘Renegotiating acquired rights in the oil and gas industries: Industry and political cycles meet the rule of law’ (2008) 1(1), J. World Energy Law Bus, 55-97; Timothy Martin and J. Jay Park, Q.C, ‘Global petroleum industry model contracts revisited: Higher, faster, stronger’, , (2010) 3(1) J World Energy Law Bus, 4-43 <doi:10.1093/jwelb/jwp022.
[4] H. Brock, H. R. Carnes, M. Z, and R. Justice, Petroleum Accounting: Principles, Procedures, and Issues, 6th Ed. Texas: Professional Development Institute (2007).
[5] Y. Omorogbe, Oil and Gas Law in Nigeria. (M.L.B., Nigeria, 2003) 209 at 38-53.
[6]K. Bindemann, ‘Production-sharing Agreements: An Economic Analysis’ O.I.E.S. (World Petroleum Market Report, Oxford) 25, 1-106 at 29.
[7]Ibid.
[8]Ibid.
[9]T. W. Wälde, ‘Renegotiating acquired rights in the oil and gas industries: Industry and political cycles meet the rule of law’ (2008) 1(1).
[10] M.M. Shaw, International Law, (6th edn, Cambridge University Press 2008) 29.
[11]Ibid.
[12] A. A. Abade, “The Principle Of Sanctity Of Contract In International Investment Agreements: The Role Of Bilateral Investment Treaties In Africa”, available at http://erepository.uonbi.ac.ke/bitstream/handle/11295/98208/Abade_The%20Principle%20Of%20Sanctity%20Of%20Contract%20In%20International%20Investment%20Agreements%20The%20Role%20Of%20Bilateral%20Investment%20Treaties%20In%20Africa.pdf?sequence=1&isAllowed=y last accessed (8 November 2018).
[13]ICSID Case No. ARB/05/8, IIC 302 (2007).
[14]R. Higgins, The Taking of Property by the State: Recent Developments in International Law, Hague
Recueil des cours, Vol. 176 at p. 305 (1982).
[15]A. Z. El Chiati, Hague Recueil des cours(1987-V), p. 24.
[16]The principle of permanent sovereignty over natural resources has been formulated, developed and
reiterated in a number of Resolutions of the UN General Assembly, extending inter alia from Resolutions 523
(VI) of 12 January 1952 and 626 (VII) of 21 December 1952, through Resolution 1803 (XVII) of 14 December
1962 and Resolution 2158 (XXI) of 25 November 1966 to Resolution 3281 (XXIX) of 12 December 1974 by
which the Charter of Economic Rights and Duties of States was adopted. See also Daintith and Gault, op. cit.,
footnote 58, pp. 28 ff.
[17]K. Hossain, Legal Aspects of the New International Economic Order, (London, 1980), pp. 33–43.
[18]Le Leuch, H. (1988) “Contractual Flexibility in New Petroleum Investment Contracts”, In: Beredjick, N. &
Walde, T. (eds.) Petroleum Investment Policies in Developing Countries. Graham & Trotman London.
[19] B. Maier, “How has international law dealt with the tension between sovereignty over natural resources and investor interests in the energy sector? Is there a balance?” (2010) I.E.L.R. 2010, 4, 95-109.
[20]Ibid.
[21]A. F. M. Maniruzzaman, “State Contracts with Aliens: The Question of Unilateral Change by the State in
Contemporary International Law”, 2007 Kluwer Law International, available at http://ssrn.com/abstract=1342337 last accessed (8 November 2018).
[22]H. Cattan, The Evolution of Oil Concession in the Middle East and North Africa (1967), New York, p. xi.
[23]H. Merklein, ‘Production-sharing contracts: a dying breed?’ (February 3, 2010) Iraq Oil Report
<http://www.iraqoilreport.com/business/economics/production-sharing-contracts-a-dying-breed-3780/> accessed 22/5/2011.
[24]Ibid. Note 7.
[25]Between 2006-2008, Algeria, Ecuador and Kazakhstan introduced Windfall Profits Taxes, with the latter passing a law to allow retroactive changes to PSCs. See K. Hossain, Natural Resources: Heritage of Nations and Mankind in The Spirit of Uppsala (AtleGrahl-Madsen and Jiri Toman, eds.) (1984) pp. 302–7. See also K. Hossain, Law and Policy in PetroleumDevelopment: Changing Relations Between Transnationals and Governments (London, 1979), pp. 182–199.
[26]H.Merklein, ‘Production-sharing contracts: a dying breed?’ (February 3, 2010) Iraq Oil Report
<http://www.iraqoilreport.com/business/economics/production-sharing-contracts-a-dying-breed-3780/> accessed 22/5/2011.
[27] P. D. Cameron, ‘Stabilisation in Investment Contracts and Changes of Rules in Host Countries: Tools for Oil & Gas Investors’ Association of International Petroleum Negotiators (AIPN), Final Report, 1-116 at 52 <http://lba.legis.state.ak.us/sga/doc_log/2006-07-05_aipn_stabilization-cameron_final.pdf> accessed 2/6/2011.
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