Academic journal article Houston Journal of International Law

The Era of Petroleum Arbitration Mega Cases: Commentary on Occidental V. Ecuador, ICSID Award, 2012

Academic journal article Houston Journal of International Law

The Era of Petroleum Arbitration Mega Cases: Commentary on Occidental V. Ecuador, ICSID Award, 2012

Article excerpt

A. The Execution of an International Farmout Agreement.

Literature on international farmout agreements is not abundant despite the fact that farmout agreements are in the heart of the petroleum upstream industry, at an important level, such as host government contracts or joint operation agreements. (125) The reason why farmouts are so relevant for the oil industry is because they allow a party carrying out exploration and production activities to diversify geological, financial and political risk with other companies in the sector. (126) In a transnational industry that cooperates world-wide in joint agreements for upstream operations assignments occur in day-to-day basis.

As Talus et al. pointed out, "[u]nlike many other industries, the international oil industry has a long history of cooperation. While competition between large IOCs can be fierce in some areas, like the marketing of petroleum or the downstream operations, the exploration and production phase are marked by cooperation between competitors." (127)

In the U.S. oil industry, a farmout exists as a common practice between private owners of rights. (128) As a country where oil ownership resides privately with persons, and not the state, this arrangement took its shape from practices obtained in that country's agriculture business long ago, where sharecroppers could earn a share in the proceeds from the farmer's crop by working on the farm. (129) This practice was translated to the petroleum industry and it has been recognized and performed internationally. (130) However, when government authorization is required, as it is in most cases dealing with hydrocarbon rights under the control of the State, bureaucracy and government policy priorities may play into the risk and performance of this operation by foreign investors. (131) Governmental approval may or may not occur. (132) For reasons of public policy the state is sovereign to choose its partners in strategic energy projects working in its territory, and this is also recognized by the oil industry. However, in performing international contracts submitted to international arbitration and also under the provisions of a BIT, the state has the duty to comply with international commitments regarding foreign investors.

The international practice of farmout agreements also has looked alternatives to the performance of this practice. One of them has been the possibility of bifurcating the title, as was tried by Occidental in the present case. (133)

This consists of executing a farmout agreement in two phases: (1) the earn-in phase; and (2) the transfer-of-title phase which occurs after the farmee has completed his obligations and government approval has been granted. (134) The Occidental case alerts us to be cautious in international operations because of issues that arise out of the bifurcation of title in farmout agreements. However, in standard situations where titles have not been transferred by contracts or "de facto", there is no possibility of liability in breaching contracts and national laws since privity never exists between the host government or the NOC, and the farmee maintaining the farmout operations as a financial transaction. (135).

According to the Industry practice, the Association of International Petroleum Negotiators (AIPN) published a Model Farmout Contract in 2004 (currently in the process of being updated). (136) It represents the international practice of these transactions. (137) In the Model of Farmout Contract, the requirement of government approval is a fundamental element to conclude the transaction. It establishes that in the case of failure to receive government authorization, the farmor must compensate the farmee for his investment and the farmee has the right to terminate the contract. (138) This unilateral right of termination is a right granted to the farmee in order to protect his position in the worst scenario. The rule is inserted in a model contract from a specialized association in the petroleum industry which shows the generally accepted practice. …

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