Enforcing Oil and Gas Contracts Without Courts

Abstract

Abstract: Amidst the recent record-breaking spike in oil prices, many resource-rich countries have moved aggressively to increase national control over large, internationally-financed hydrocarbon projects. Commentators have sensationalized these breaches as politically-motivated moves toward resource nationalism and a reflection of a weak rule of law. This commentary, however, oversimplifies a complex phenomenon. Many countries accused of resource nationalism have selectively renegotiated contracts and have stopped far short of full-scale nationalization. Furthermore, other resource-rich countries--often with weaker systems of legal enforcement and similar political incentives to renegotiate--have reacted to the oil boom by respecting long-term contracts and encouraging additional foreign investment. Russia and Azerbaijan can help us understand the forces driving these recent developments in the hydrocarbon industry: while Russia has renegotiated long-term contracts and partially re-nationalized its hydrocarbon industry, Azerbaijan has done the opposite. Comparing these two countries, this article will propose that these differing responses are strategic reactions to the oil boom. Both countries still require access to the technology, capital, and political connections of international oil companies to pursue their interests; thus, the ex post reputational costs of contractual breach have helped insulate long-term contracts from expropriation in the absence of a strong role of law. Thus, like in other business communities that do not have access to impartial court systems to enforce contracts, maintaining a good reputation has emerged as a key factor in ensuring the stability of existing long-term hydrocarbon contracts. Keywords: Azerbaijan, hydrocarbon, rule of law, Russia ********** The spike in oil between 2003 and 2008 has transformed the dynamics of hydrocarbon investment. From South America to Central Asia, resource-rich countries have unilaterally renegotiated contracts and imposed national control over long-term hydrocarbon projects. Commentators and analysts have described these partial or full-scale nationalizations in the developing world as a return to a 1970's style of resource nationalism riding along the crest of high prices (2) and typical of nations with a weak rule of law? They have been particularly critical of post-Soviet countries, describing recent state-forced renegotiations in Russia and Kazakhstan as short-sighted and politically motivated. The reality, however, is far more complex. Rapid, full-scale nationalizations, which typified the 1970s, have not been the order of the day. Many of these contractual disputes have resulted in negotiated solutions: resource-rich countries have offered international oil companies (IOCs) reduced shares, and many IOCs have accepted. Finally--and most strangely--other resource-rich, developing countries like Azerbaijan, despite weak rule of law and the potential of capturing skyrocketing revenue streams, have resisted the temptation to override their long-term contractual obligations and capture skyrocketing rents. This article will seek to understand the stability of hydrocarbon contracts in the former Soviet Union. In the absence of a strong rule of law, can IOCs expect resource-rich countries to respect the bargained-for terms in long-term hydrocarbon contracts if oil rise or political circumstances change? In other words, are there factors other than courts that can constrain the grabbing hand of the state in the high stakes hydrocarbon contracting game? The answer to these questions will help shed light on the complex relationship between law and investment risk in long-term, cross-border hydrocarbon contracting. Back to the 1970s: No Courts, No Protection The dominant paradigm for understanding post-Soviet hydrocarbon contractual renegotiations goes as follows. The recent oil boom has freed resource-rich, post-Soviet countries from dependence on IOCs. …