Academic journal article Stanford Journal of Law, Business & Finance

Preventing the Inevitable: The Benefits of Contractual Risk Engineering in Light of Venezuela's Recent Oil Field Nationalization

Academic journal article Stanford Journal of Law, Business & Finance

Preventing the Inevitable: The Benefits of Contractual Risk Engineering in Light of Venezuela's Recent Oil Field Nationalization

Article excerpt

"[T]He fact that we as a company still believe in the rule of law and the sanctity of contracts is not something that we will easily abandon."

-Former Exxon Mobil CEO Lee Raymond1

"It's naïve to expect stability in a developing country."

-Anonymous Big oil executive2

Introduction

Last year, Venezuela completed its most significant oil field nationalization in 30 years. Pursuant to President Hugo Chávez's mantra, "all of that which was privatized, let it be nationalized,"3 Venezuela first successfully renegotiated approximately 90% of the 20- to 35-year concession contracts that it awarded in the mid-Nineties.4 The new terms of those projects provided for increased taxation, increased royalties, increased proportional equity for Venezuela's state-owned oil company, and a decrease in the investors' ability to pursue legal remedies. As evidence of the government's impressive progress, only one case of those renegotiations devolved into litigation.

Last year, emboldened by this success and the high price of oil, Venezuela then set its sights on divesting equity from the four most valuable projects awarded during the Nineties: the multi-billion dollar Orinoco Delta projects which were the country's only remaining privately controlled oil installations. The same country that only ten years prior had attracted foreign oil companies with lucrative terms in these 30- to 35-year Strategic Association Agreement (AA) contracts for development and production now suddenly demanded majority stakes via "renegotiations" under threat of wholesale expropriation.5 After the foreign oil companies had already invested more than $15 billion in developing the fields' production potential, a new state doctrine of "Full Energy Sovereignty" urged quick divestment.6 Most of the oil companies already invested in the AA projects acceded to the expropriations, but both Exxon Mobil and ConocoPhillips refused. Late last year, both filed separately for international arbitration with the International Centre for Settlement of Investment Disputes (ICSID). In its case, Exxon Mobil has already won court orders in the U.S., U.K., the Netherlands and the Caribbean freezing more than $12 billion in Venezuelan assets.7

These dramatic manifestations of and reactions to Venezuelan President Hugo Chávez's "21st Century Socialism" exemplify the political risk inherent in international business transactions, and in particular the heightened political risk of foreign direct investments with high sunk costs.8 As a legal matter, the recent expropriations9 in Venezuela shed light on the extent to which companies making long-term investments with high sunk costs in foreign jurisdictions may engineer out political risk via contracts. In such situations, the private party's contract drafters must both anticipate political risk and devise techniques to insulate the investor from that risk. Frequently, for instance, a contract will provide for recourse to international arbitration as an external check on a host country's weak judiciary.

In that vein, this Article examines the renegotiations of the four heavy oil projects in Venezuela's Orinoco oil belt by exploring two principal inquiries: (1) Relatively speaking, how successful were the foreign oil companies in engineering out the risk of their investments via long-term contracts? and (2) What do the oil companies' divergent choices about whether to pursue arbitration reveal about the value of provisions for international arbitration as an external legal check? We will approach these questions by analyzing the terms of the original contracts, prior and subsequent to political and legal events in Venezuela, and the oil companies' incentive structures regarding invocation of international arbitration.

As will be shown, however prescient the oil companies were in drafting flexible contracts that allocated away political risk and provided for international arbitration, changes in the price of oil and politics in Venezuela created a situation in which most of the oil companies found it necessary to cede some of their benefit of the bargain without resorting to arbitration. …

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