Preserving the Contractual Equilibrium of International Petroleum Contracts: A Relational Contract Analysis

The viability of long-term investment contracts is dependent on the effective and efficient distribution of risk and reward between the parties, while retaining the potential for flexibility in the face of future pressures for alteration. Petroleum contracts as long-term state contracts have complex economic and legal aspects, and their performance depends upon a durable relationship between the investor, whether foreign or domestic, and the host government. Such contracts cannot be seen as discrete commercial transactions or isolated agreements. Hence, the sustained contractual relationship for petroleum transactions is based on the ability to accommodate changing expectations in changing circumstances, and on the ongoing balance and adjustment of contractual rights and obligations in changed framework. International energy investment agreements are very vulnerable and exposed to a range of actions or inactions by public authorities (government or state agencies) which could considerably affect the profitability of a project. Amongst the principal reasons for the risk of expropriation is that the host state seeks to obtain a greater share of the return from a successful operation, by raising taxes or tightening other provisions in the investment contract without necessarily taking over ownership of the investment or to drive the investor out of business. As a result, the business relationship between the foreign oil company and host government resembles a model of an ‘obsolescing bargain’, (OBM). The thesis explores the role of the contractual equilibrium and bargaining positions and their interactions with contractual clauses in a relational model of relationship to reduce and manage risk of expropriation in international energy investment transactions. The thesis examines the classical and the relational theories of contract and their response to contractual obligations, and then suggests an adaptive contractual mechanism to maintain the equilibrium of the contract in order to protect the contracting parties’ interests and resolve disputes.