International Arbitration in the Energy Sector

*Professor Researcher - LERJP, Faculty of Law, Economic and Social Sciences of Souissi, Mohammed Vth University of Rabat, Morocco

Abstract ita

Molti paesi in tutto il mondo dipendono dal settore energetico per l'industria, la sicurezza nazionale, la mobilità, l'economia e innumerevoli altri vantaggi. L'importanza del settore energetico e la diversità degli interessi dei principali stakeholder aumenta la probabilità che sorgano controversie. È quindi essenziale che il settore dell'energia adotti meccanismi efficaci di risoluzione delle controversie. In questo contesto, l'arbitrato è diventato parte integrante del processo di risoluzione delle controversie internazionali nel settore dell'energia, anche attraverso la sua incorporazione in accordi internazionali di investimento.

Abstract eng

Many countries around the world depend on the energy sector for industry, national security, mobility, the economy and countless other benefits. The importance of the energy sector and the diversity of interests of key stakeholders increase the likelihood of disputes arising. It is therefore essential for the energy sector to adopt effective dispute resolution mechanisms. In this context, arbitration has become an integral part of the international dispute resolution process in the energy sector, notably through its incorporation into international investment agreements.

Contents: 1. Introduction. 2. Overview of the evolution of disputes in the energy sector.

3. Arbitration and the renewable energy sector. 4. Energy disputes and Investor-State Dispute Settlement (ISDS). 5. Risks associated with arbitration clauses. 6. Conclusion.

1. Introduction

Although usually a last resort, formal legal proceedings may be the only way to resolve a dispute and obtain damages. Contractual dispute resolution mechanisms are an important tool for ensuring that any disputes are settled quickly and firmly. Yet these clauses often receive little attention at the drafting stage, or may be based on potentially unsuitable precedent.

In the energy sector, common causes of disputes are often due to the cancellation of exploration and production (E&P) projects, resulting in contract renegotiation or termination. These situations can lead to disputes over issues of contract formation or performance, as well as termination rights. It is well known that long-term supply agreements for natural resources generally retain a degree of flexibility to allow renegotiation of important issues, such as prices or delivery schedules. However, parties to contracts that are no longer competitive due to current market conditions are now making use of these provisions, leading to disputes. As an example, gas buyers have begun to review prices under long-term gas agreements that contain flexible pricing mechanisms based on the oil price. Financial defaults - for example, in the borrowing bases on upstream financing - insolvency and illiquidity in 2014 and 2015 were frequent catalysts for disputes. The collapse of the OW Bunker Group triggered multiple disputes between buyers and sellers of marine fuel oil. Fraud often surfaces in unfavorable market conditions. For example, the Qingdao warehouse fraud, which led to multiple disputes between metal traders, warehouse managers and financing banks. The Petrobras "Operation Car Wash" scandal is another example of corruption.

Disputes in the energy and natural resources sector are at the heart of international arbitration. As the international energy sector is the one with the highest number of arbitrations, it is not surprising that the most important awards in the history of arbitration have come from energy-related arbitrations. Energy disputes often involve complex and controversial issues of security, sovereignty and public welfare. International Energy Arbitration places international energy disputes in a global context, offering broad coverage of the different forms and systems of dispute resolution in the renewable and non-renewable sectors. With contributions from leading arbitrators, practitioners, academics and industry experts from around the world.[1]

Drawing on analyses of arbitral awards, decisions of national courts and international tribunals, treaties and other international legal instruments, as well as current events and news from the energy sector, this article offers a contribution to the international energy literature and provides an insightful commentary on the issues that arise in this field.

2. Overview of the evolution of disputes in the energy sector

It is undeniable that disputes in the energy sector continue to dominate international arbitration, both in terms of number and value, with the highest awards in history coming from energy-related arbitrations. This seems immutable.[2]

As a result, the fallout from lower oil prices in recent years has led to a reduction in exploration and development, with projects suspended or even halted. Joint venture agreements are, of course, widespread in the energy sector, and the economic impact of lower oil prices has hit participants in production sharing and joint operating agreements hard, leading to considerable budgetary and commercial defaults or disputes. These have led to a growing number of disputes between operators and non-operators over license obligations, as well as disputes over royalty payments, as operators struggle to maintain cash flow to continue financing and operating. Conversely, the reduction in the number of active projects has led to a decrease in disputes between employers and contractors.[3]

Then with the change in oil prices, although bankruptcy filings linked to lower oil prices are far from over, the number of new bankruptcies of exploration and production companies, midstream companies and oil service companies has decreased. Litigation will continue to overshadow historic bankruptcies, since, by becoming insolvent, these companies are likely to have breached a number of contractual obligations, leading to claims from counterparties. Furthermore, as more complex, difficult and costly projects (both onshore and deepwater) resume, operational problems and disputes are likely to increase.[4]

The gas sector was also a frequent battleground. The change of political regime led to major cross-border gas supply disputes and international arbitration. In addition, as many Liquefied Natural Gas (LNG) contracts were traditionally indexed to oil, there were a significant number of high-value LNG price review arbitrations over many years. Dynamic markets, coupled with price volatility, have led buyers or sellers under long-term supply contracts to seek to take advantage of price review provisions to adjust the LNG price in line with changing market conditions. Arbitration is generally the forum for resolving such disputes. Since LNG price revision disputes arise from a party's attempt to negotiate on the basis of a contractual right, and result in the application of that right by an arbitral tribunal, they are different from other commercial disputes.[5] That's why their prevalence has given rise to a whole new form of energy arbitration. If any sector is in the running to win the competition for the world's most important commercial arbitrations, then LNG price review disputes are likely to remain a good bet, given that the value of these cases can reach the billion-dollar mark.[6]

In Europe, since wholesale gas contracts are now more often linked to natural gas price indexation, and there's not much left to say on the subject, this roadshow has calmed down, but it could resurface in Asia-Pacific and other regions where LNG contracts remain indexed to oil.[7]

3. Arbitration and the renewable energy sector

The energy sector has undergone a major transformation in recent years, thanks to the rise of renewable energy sources that rival the dominance of the major players of recent decades, such as coal, oil and natural gas.[8] Over time, arbitration has become an effective tool used to negotiate the outcome of disputes in the ever-changing renewable energy sector as new technologies emerge, and in recent years third-party financing has played a very important role in renewable energy arbitration.[9]

To survive, renewable energy companies and projects often depend on large initial investments that cannot be recouped in the short term. To encourage such investments, many countries, particularly members of the European Union, have adopted regulatory regimes that offer investors incentives such as special rates or tariffs. In fact, companies investing in countries that have signed bilateral investment treaties (BITs) are not only more likely to obtain larger loans on more favorable terms, but are also more likely to invest in these countries in the first place.

The most important BIT to impact the renewable energy industry is the Energy Charter Treaty (ECT), and international arbitration has long been used as the main dispute resolution mechanism for large-scale energy disputes.[10] The energy sector is one of the biggest players on the international arbitration scene, with some of the highest awards in history having been made in energy-related arbitrations. In addition to more traditional commercial arbitration scenarios, the energy sector has seen a significant increase in investor-state disputes arising from various BITs.

In particular, thanks to its incorporation of multiple dispute settlement mechanisms to deal with a variety of types of grievance that might arise if states failed to meet their treaty obligations, arbitrations brought under the ECT are unlikely to decline any time soon. Since 2001, 114 investment arbitration cases have been registered under the treaty. Most TCE arbitrations base their claims on two specific provisions of the treaty: its requirement that host states offer fair and equitable treatment to foreign investors, and its prohibition on expropriation. As international arbitration expands, costs increase, which in turn leads parties to seek alternative means of financing these costs.[11]

Renewable energy arbitration is a rapidly expanding platform and, as such, it is essential that all parties involved are aware of the potential benefits that third-party financing can have on their claims. That's why, in the future, we need to look at the renewable energy boom that has unleashed a new era of clean energy.

4. Energy disputes and investor-state dispute settlement (ISDS)

International arbitration remains the most popular choice for global investors to protect their international investments. The possibility of initiating arbitration proceedings is normally provided for in international investment agreements. These instruments come in a variety of forms, including bilateral investment treaties (BITs) and multilateral investment treaties (MITs).

What distinguishes investment arbitration from commercial arbitration (and other dispute resolution forums) is that only the investor can initiate arbitration proceedings against the state. The investor can do so when it considers that the state has failed to respect the commitments agreed between the state and the investor's home country. According to the Organization for Economic Co-operation and Development's (OECD) public consultation on investment arbitration, dispute settlement mechanisms such as investment arbitration represent a means for governments to ensure the credibility of commitments made in various international investment agreements. Similarly, the stronger the protections provided to the investor under the treaty, the greater the possibility of foreign investment, since strong protections indicate low long-term risk for investors.[12]

In general, these investment instruments include multiple protections for foreign investment. When these protections are violated by the home state, the investor can initiate arbitration. International investment agreements include four main forms of protection for investors in foreign states. Firstly, most IIAs provide for fair and equitable treatment, which is an unconditional form of protection. Although the substantive content of fair and equitable treatment has been fleshed out by arbitration tribunals on a case-by-case basis, it can generally be defined as the prohibition of arbitrary decision-making, discrimination and abusive treatment of foreign investors. The principle of fair and equitable treatment is considered the cornerstone of most investment treaty obligations. This principal feature, for example, in the North American Free Trade Agreement (NAFTA), as well as in the Energy Charter Treaty (ECT).

Most treaties also protect against discriminatory practices. It is only natural that every state entering into an agreement should wish to be treated on an equal footing with all other states. These non-discriminatory protections may include non-discriminatory treatment or "most favored nation" clauses. These protections essentially prohibit a state from treating one foreign investor differently from any other: if one trading partner benefits from a tax subsidy, all trading partners must be offered the same privilege.

International investment agreements also offer investors protection against expropriation of an investor's assets by the state. Such expropriation may occur through the nationalization of assets or enterprises, or through actions that may affect the sustainability of an investment. Although expropriation may be legal, provided certain requirements (such as compensation) are met, where the expropriation fails to meet general requirements, it may be considered an offence under which an investor may bring a claim for investment arbitration.[13]

The final protection normally provided by international investment agreements is the protection of the transfer of funds, which may include the payment, conversion or repatriation of investments from a host country to the investor.[14]

Unlike BITs, the ECT contains broad definitions of investment and investor, which may explain its increased use by investors. The ECT provides investor protections aimed at reducing the commercial risks associated with energy investments, including non-discriminatory treatment and compensation for expropriation, as well as improved energy efficiency and investor-state dispute settlement mechanisms. This is reflected in recent complaints about changes to renewable energy regimes, in particular the abolition of feed-in-tariffs (FITs) for energy investments.[15]

5. Risks relating to arbitration clauses

One of the main risks associated with an imprecise or ill-conceived dispute resolution clause is that attempts to resolve disagreements may be disrupted or delayed by a recalcitrant counterparty. For example, the following situations may arise at the outset of a dispute in the energy sector, where contracts are often concluded between parties from different countries: A counterparty may rely on an imprecise clause to challenge the jurisdiction of a court or tribunal, or initiate legal proceedings elsewhere on the disputed issues. The result is likely to be deadlock and costly litigation on jurisdiction, rather than on the merits of the claim. In this way, the counterparty can delay the resolution of the dispute for several years.[16]

In an arbitration context, parties sometimes give little thought to the seat (or legal venue) of arbitration, perhaps without understanding its legal significance. If the chosen seat lacks sufficient or unforeseeable judicial support for the arbitration, this can give an uncooperative party the opportunity to challenge the arbitration process in court, for example with regard to the appointment or qualifications of the arbitrators. Here again, the counterparty may delay the resolution of the dispute for several years.

In addition, the dispute resolution clause may be unclear as to which resolution procedure should apply to a particular dispute. In complex energy transactions, parties often wish to include hybrid, multi-level, single-option or exclusive dispute resolution processes. These can be adapted to provide multiple dispute resolution mechanisms on an incremental basis and/or require particular disputes to be subject to particular procedures. Most begin with Alternative Dispute Resolution (ADR) before moving on (or substituting) for more formal resolution through litigation or arbitration. There are several well-established means of ADR in an energy context, including compulsory negotiation (often involving increasingly experienced personnel after each failed step), expert determination, mediation and in the event of non-agreement proceeding to arbitration.

6. Conclusion

The international energy industry often gives rise to complex, high-value disputes. As economic and commercial circumstances change, joint venture partners may disagree over operations, sellers and buyers may maneuver to alter pricing conditions, and states may seek to improve their grip on investment projects. Each of these outcomes can have significant consequences for the long-term prospects of companies in the sector.

These are just some of the issues covered in this article, which provides a practical, user-friendly overview of the essentials of international arbitration in the energy sector. Leading practitioners from international law firms and global corporations examine, among other things, the effective drafting of arbitration clauses, how to keep international arbitration affordable, gas price arbitrations, equipment and construction arbitrations, investment treaty disputes under the Energy Charter Treaty, third-party funding in international arbitrations and the enforcement of arbitral awards.

After all, there is no single approach to dispute resolution in the energy sector. Parties need to consider their individual needs when drafting dispute resolution clauses. Specific expertise, the importance of early resolutions and the multi-party, multi-contract scenario, as well as the enforceability of the decision, are aspects to be taken into account. Finally, it can be said that arbitration offers the flexibility needed to work out tailor-made solutions.

[1] See Wetterfors J., The First Investor-State Arbitration Award under the 1994 Energy Charter Treaty. Nykomb Synergetics Technology Holding AB, Sweden vs. The Republic of Latvia. A case Comment.

[2] See Scherer, M. ed., 2018. International Arbitration n The Energy Sector. Oxford University Press.

[3] See Kérébel C. (2008), Quelle gouvernance du marché du pétrole aujourd'hui? Mécanismes, systèmes d'acteurs et rapports de force en évolution", in L. Spetschinsky and T. Struye (eds.), La Gouvernance de l'énergie de l'Europe et dans le monde. Struye (eds.), La Gouvernance de l'énergie de l'Europe et dans le monde, Louvain, Presses universitaires de Louvain, p. 13-31.

[4] See Baker Institute (2007), The Changing Role of National Oil Companies in International Energy Markets, Baker Institute Policy Report, n° 35.

[5] See Onwuamaegbu U. (2004), Resolution of Oil and Gas Disputes at ICSID, News from ICSID, vol. 21, n°1

[6] AIE (2003), World Energy Investment Outlook.

[7] AIE (2008b), St. Petersburg Plan of Action Global Energy Security, IEA evaluation of G8 countries' progress in 7 key action areas.

[8] See Cosbey A., L. Peterson, H. Mann et K. von Moltke (2003), Investment, Doha and WTO, The Royal Institute of International Affairs/Institut international du développement durable.

[9] See J. William Rowley QC (2017), The Guide to Energy Arbitrations, Global Arbitration Review, 2^nd Edition, Editor's Preface, pvii.

[10] See Konoplyanik A. et T. Walde (2006), Energy Charter Treaty and its Role in International Energy, Journal of Energy & Natural Ressources Law, vol. 24, n° 4, p. 523-558

[11] Keppler J. H (2007), La sécurité des approvisionnements énergétiques en Europe : principes et mesures, Note de l'Ifri.

[12] See Herbert Smith LLP (2004), Investor Wins First Award under the Energy Charter Treaty, Herbert Smith International Law Briefing, October 2004

[13] See Alcabas A.-M. (2003), The International Centre for Settlement of Investment Disputes. Note bleue de Bercy n° 256.

[14] World Bank (2008), Upstream Oil and Gas: Securing Supply, working paper for the 11th International Energy Forum.

[15] See Konoplyanik A. (2006), Energy Charter: The Key to International Energy Security, Petroleum Economist, vol. 73, n° 2, p. 19-20.

[16] See Keppler J. H. (2007), International Relations and Security of Energy Supply: Risks to Continuity and Geopolitical Risks, external study for the European Parliamentary Committee on Foreign Affairs.