Confronting the Obsolescing Bargain: Transacting around Political Risk in Developing and Transitioning Economies through Renewable Energy Foreign Direct Investment

Article excerpt


Access to a reliable source of energy is indispensable to the stability of all nations. (1) Beyond the requirements of domestic demand, energy access is a component of any national security program and can be a primary source of wealth in producing countries. Energy producers' ability to shut off world supply gives them a powerful bargaining position politically and economically. (3) Recent expropriations of foreign energy investments in fossil fuel producing countries demonstrate the vulnerability of international energy investments to government intervention. (4) As an alternative, some investors avoid the fossil fuel market altogether and instead choose renewable energy. (5)

This Note argues that investment in renewable energy is an attractive method of mitigating political risk in developing and transition economies. (6) Part II introduces political risk and provides a brief description of the common methods of risk mitigation. (7) Part III examines expropriation through the lens of two high-profile case studies, Russia and Venezuela, and highlights the increasing global significance of renewable energy projects. (8) Part IV analyzes the attractiveness of clean energy projects in comparison to fossil fuel projects in light of the difficulties of arbitrating investor-state disputes. (9) Part V reaches the conclusion that by choosing renewable energy projects, investors can reach markets that would otherwise be closed to foreign direct investment (FDI) because of the expropriation threat, but cautions that renewable energy projects are not a panacea for political risk. (10)


A. Increased Risks of Foreign Direct Investment

Foreign direct investment presents a lucrative opportunity for the investors but also entails numerous risks, such as property loss if the political environment changes. (11) Developing and transition countries receive a large percentage of world FDI because of the confluence of three factors: inexpensive labor, market growth potential, and wealth of natural resources. (12) Political risk is an ever-present danger of FDI that is especially profound in the energy sector. (13) During an economic slowdown, political leaders may appropriate foreign assets to make up for the host country's losses. (14) When commodity prices rise, political leaders may be tempted to repudiate contracts that imposed ceilings on royalty payouts to host countries. (15)

The 1962 United Nations Resolution on Permanent Sovereignty Over Natural Resources and the 1974 United Nations Declaration on the Establishment of a New International Economic Order, announced the principle that host countries are free to control their natural resources despite contractual agreements granting rights to foreign corporations. (16) Host countries eager to assert their independence utilize this principle to justify expropriating foreign projects once they reach the production stage. (17) This "obsolescing bargain" is particularly prevalent in developing countries and those in transition from planned to market-based economies. (18) Frequent regime changes in such countries often increase their leaders' reluctance to recognize that prior contracts remain binding on current administrations. (19)

When investors operate in foreign legal regimes, they face an increased level of general business risk uncommon in domestic ventures. (20) Contract risk, specifically the risk of repudiation, increases when the counterparty is a foreign government entity. (21) Another example of the increased risk of FDI is currency risk, which includes the risk of currency devaluation, convertibility problems, and limitations on currency transfer from the host. (22)

B. International Investment Protection

1. Transaction-Based Risk Mitigation

The importance of taking proactive dispute prevention measures before conflicts materialize cannot be overstated. …


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