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Crude oil exporting countries are going through difficult times, with the energy markets they depend on for their export earnings in turmoil. For many of these countries, a persistently low oil price will make it difficult to balance the national budget and deplete foreign currency reserves. Furthermore, the hardest hit may well be countries already plagued by other problems, such as political instability, security concerns and corruption.
Collapsing oil prices can precipitate significant policy changes. Algeria provides a classic example – the fall in oil prices in the 1980s preceded an economic crisis, drastic austerity measures in order to continue to service the external debt, political unrest and, ultimately, a civil war. Algeria is facing this latest drop in the price of crude after more than a year of protests for political reform and it is certainly not the only oil exporting country in which the stability of the political environment is already weak.
There is a clear link between oil exporting countries and FDI inflows. Not only international oil companies (IOC) engaged in long-term exploration and production projects, oil revenues regularly fund other capital-intensive state projects (such as infrastructure or telecommunications), which projects are often backed by investment strangers. As states respond to low oil prices, including dealing with the resulting economic and/or political fallout, it is almost inevitable that foreign investors will be affected.
As discussed in our podcast here, CIOs will look to contractual protections to the extent the state is a party to those contracts. However, foreign investors facing state action that impairs their investment may also consider recourse under international law, through the protections contained in investment treaties.
Investment treaties are agreements between two or more States containing reciprocal commitments for the promotion and protection of private investments made by nationals of the signatory States in the territory of the other. Such agreements have historically been entered into to provide confidence to foreign investors that their investment will not be adversely affected by certain types of improper actions of the host state of the investment (the “host” state) and that, if c is the case, to allow the investor to claim damages. Most commonly, these are bilateral arrangements (known as bilateral investment treaties or BITs), multilateral treaties, or free trade agreements that contain investment protections. Investment treaty protections can be enforced against the host state by investors from the other state, usually through international arbitration.
Each treaty should be considered on its own terms, but they generally include the following investment protections:
- protection against unlawful expropriation of an investment without adequate compensation, either directly or indirectly through a series of governmental acts that impinge on an investment and cause its loss in value;
- the Fair and Equitable Treatment Guarantee (or FET), which is recognized to protect investors against arbitrary or discriminatory exercise by the host state of its regulatory power, procedural unfairness or lack of due process, bad faith or failure to protect a legitimate expectation of investors as to how they will be treated. Stabilization clauses – often found in state oil contracts and discussed in our previous podcast here – can be very relevant when it comes to this last aspect of the FET guarantee;
- a guarantee of full protection and security for the investment and for the investor, which is generally understood as relating to the physical protection of the investment by the State but which has been found to encompass legal protection;
- guarantees of treatment no less favorable than those granted either to nationals of the host State of the investment, or to nationals of third States, which prevent the host State from discriminating against the foreign investor;
- a so-called “umbrella” clause, which may have the effect of bringing within the scope of the BIT protections other State obligations contracted in the context of an investment; and
- the right to repatriate profits and capital.
So how can states react to the fall in the price of oil, and how can an investment treaty be relevant for foreign investors in the oil sector as in other sectors?
States under pressure to maintain a certain level of oil revenue may seek to increase the state share. This can be done through an express review or forced renegotiation of oil contracts to increase the state’s share, or by raising taxes or using other fiscal instruments (such as levies, taxes on corporate profits, income taxes, resource rent taxes or value added taxes). ). More general tax increases to compensate for lost oil export revenue can of course have an impact on foreign investment outside the oil industry. While investment treaties routinely contain provisions that preserve the state’s right to impose taxes, in certain circumstances such actions have nevertheless previously been held to constitute an indirect expropriation of an investment and to violate the legitimate expectations of an investor, violating the guarantee of fair and equitable treatment. When the State fails to comply with contractual obligations related to the investment, an umbrella clause may also be relevant to bring these actions within the scope of protection of the investment treaty.
Depending on the state’s exposure to low oil prices through its contracts with IOCs, there may be pressure on the IOC to renegotiate these contracts, forcing the IOC to take on a greater portion of the risk. Investors in a joint venture or other collaborative relationship with a national oil company (NOC), may face increasing state interference in the management of the NOC, which affects the contractual performance of the NOC and, ultimately, the investment. Again, depending on the circumstances, such state interference may constitute a violation of the IOC’s treaty rights. Moreover, it is possible that the actions of the NOC itself could be attributed to the state and therefore, depending on the circumstances, constitute a breach of a treaty.
States can also take extreme measures in an attempt to deal with an impending or worsening financial crisis. Faced with similar circumstances, states have voluntarily depreciated their currencies, imposed de facto capital controls by freezing certain banking activities and forced currency conversions. Such measures could constitute, for example, an expropriation and/or a violation of the protections relating to the free transfer/repatriation of profits. Beyond these immediate measures, the destabilizing effect of another oil price slump could trigger broad economic and political reform in a number of oil-exporting countries, changing the investment environment, impacting foreign investment in several ways and raising many questions around the compatibility of these actions with the treaty obligations of the State.
In addition, as discussed above, a low oil price environment could lead to or contribute to deteriorating security conditions, increased insurgency, civil unrest or disruptions. If this has an impact on foreign investment (whether or not directly related to the oil industry), the comprehensive protection and security standard may be relevant.
Investment treaty claims are very fact and treaty specific, but for foreign investors affected by state action in the context of the oil price crisis, it is certainly worth asking whether treaty remedies can provide some relief.