Author: Mihika Bhatnagar, IV yeraof B.A.,LL.B from University of Petroleum and Energy Studies.
Introduction
“Always expect the unexpected. The Oil and Gas Industry is terrible at predicting anything. Always have a back-up plan.”
Just Like other major companies and industries, the oil and gas industry saw a rise in Arbitration and Conciliation in the late 90s. It will not be wrong to say that there was somewhat a switch from the Traditional Court system to Arbitration within a span of very short time. Nowadays almost all the big companies including Oil Companies are referring to arbitration over court and the reasons are the various beneficial factors which come with arbitration. Oil and gas industry involves very complex operations in order to operate and produce the products and sometimes disputes happen. Dispute between the oil companies can happen between a lot of people who are involved both nationally and internationally and have invested their money or minerals. The Arbitration system has done more good than bad and to be honest the traditional Court system is both expensive and time consuming. Oil and gas industry is a very long, risky, and expensive in a way that the probability of success is very low. You can never be 100% sure in the case of extraction of proven resources, even with all the geographical data and reports. As there are many parties and interests involved, oil and gas disputes can be complicated. Conflicts among oil and gas suppliers, customers, contractors, and governments frequently result from circumstances that have an impact on the demand and supply of energy.
In this paper I have analysed the evolution of arbitration in the oil and gas industry and what the future holds.
Evolution of Alternate Dispute Resolution in Oil and Gas Sector
The traditional Court system was great for the Indian legal system, however the courts were already overburdened and they lacked privacy, the process was expensive and many parties, especially private parties wanted their issues to be served with full privacy and transparency. They wanted someone that they could decide to judge their matters and pass an award based on their expertise and situation and they needed less time consuming process for deliberating the legal matters. Since the end of the nineteenth century, arbitration has been a thriving legal practise in India. When the Indian Arbitration Act, 1899 was passed, arbitration was officially acknowledged as a means of conflict resolution in India for the first time. However, it was only permitted in the three presidency towns of Madras, Bombay, and Calcutta. Section 89 and Schedule II of the Code of Civil Procedure, 1908, further formalised it. The act of 1940 was passed but it couldn't fulfil all the purposes which it was assigned.
After the economic liberalisation in the year 1991, steps were taken to attract foreign investment which required a comfortable business environment and ease of doing business. For the said reason, Arbitration and Conciliation Act, 1996 came into force and repealed the Act of 1940. Naturally arbitration was loved by all the big companies specially the oil and gas company as it was exactly what they wanted in order to excel the process of dispute resolution in their premises.
Article 37 of the Hague Convention of 1907, relating to the peaceful settlement of international disputes, defined arbitration as: “a method for settling disputes between states, by judges of their choice on the basis of respecting the right and the law.”
This concept covers a wide range of techniques that can be applied singly or in a variety of ways. ADR procedures can be divided into adjudicative and consensual processes. In adjudicative processes, such as binding arbitration, the neutral third party has the authority to impose a resolution on the parties in dispute, whereas in consensual processes, such as mediation, the neutral third party merely supports the parties in coming to their own resolution.
Arbitration has helped in easing the process of serving Justice by being less expensive, less time consuming, flexible, and most importantly it provides what all the big Oil Companies need, confidentiality. Confidentiality is one of the most important factors which has led to the development of arbitration in the field of legal structure. No big Oil Company or even government wants their name to become the talk of the town especially in legal matters and arbitration is exactly what they need.
The ADR strategy best suited for resolving the issues that emerge between the lessor and lessee under the conventional oil and gas lease is mediation, whether in its pure form or in some hybrid form. The explanation is clear-cut and easy to understand. Contrary to binding arbitration, mediation has the drawback of not guaranteeing the outcome of the case. Its main benefit is that it gives the parties the freedom to come up with their own solution. Most of the time, both parties to the oil and gas lease prefer to work out their own agreements than have a judge or arbitrator impose them.
In the oil and gas context, the unique nature of the relationship between lessor and lessee may offer even greater incentives than usual for resolution of disputes through consensual means.
The extent of disputes in Oil and Gas Industry
Oil and gas industry is one of the most controversial industries in the history of the world and the industry is prone to disputes. When things do not go as planned it is very common for a dispute to arise. Oil and Gas sector disputes have been continuously arising in the past few years and what the future gases are, it will continue to arise. There are different parties in which disputes may arise for example between the host country and the oil country, the foreign country and the host country, between the landowner and the oil company, between different Oil Companies and many more. Many times the revision in the regulatory provisions threaten to dilute the value of the project with regards to tax or fiscal regime and as a result disputes happen. Many times overlapping borders result in Offshore Maritime disputes which usually result in the exercise of sovereign rights on the Exclusive Economic Zone (EEZ).
The most common of all these disputes is the oil and gas lease dispute. Black’s Law Dictionary defines Mineral lease as, “In exchange for predetermined compensation, this is a specific type of lease arrangement between an entity and a property owner. It grants the entity the rights to explore to determine if minerals are present and, also, to extract minerals, like iron, copper, oil, or even natural gas, from the leased property.”
What usually happens is the land owner who owns both the land and the minerals is approached by the representative of an oil company. The representative most often works in the oil company especially in the exploration department and seeks to proceed with the exploratory drilling after conducting through geological survey, a lease is created and the legal owner of the land becomes the part of the lease. Proper blocks are determined in order to create the lease area the land owner must also have the mineral rights. Everything should be in order before the lease presentation.
After the landowner signs the least he receives a ‘bonus’ the time period mentioned for lease period is called ‘term’. Another crucial part of the lease is the ‘royalty’ which is basically the agreed percentage of profit of oil and gas.
The lessor’s business goals under the oil and gas lease is basically to obtain profit by only investing the mineral land; they do not bear any cost of development in any way. Maximum development equals maximum royalty. The lessee’s business goal is maximum development, however they are the ones who carry all the risk and the development activities. A ground for dispute is also whether the lease allows the production company to deduct expenses for post-production cost before paying royalty to land owner or not. Breach of contract happens when a company drills the well and later on does not follow up.
Oil and gas lasers grant to the Exclusive rights to conduct geophysical and systemic operations and again the dispute arises when the leaf is unclear as to the extent. A similar kind of issue happens with joint mineral owners’ rights. Another common ground for disagreement is generally the rights granted to the lessee and those which are retained by the lesser.
Another disagreement is related to the title of the land. Subsequent transfer by lesser results in title issues such as apportionment of royalty. Lease terminating events results in shut off royalty dry hole, delay rental and the revenue cancellation issues arise and the question is what will the lesser received as compensation under the oil and gas lease. Since the oil and gas lease a long-term lease it is very common for such disputes to happen and it is very important to get this issues settled as soon as possible and by maintaining full confidentiality
In large-acreage plays, disagreements under the exploration agreement frequently occur regarding the choice of drilling prospects, the precise kind of work to be done, the horizons to be tested, and how those tests should be conducted. Most importantly, however, is the prompt payment of each participant's portion of the development's costs.
Environmental claims, shareholder value-related difficulties, regulatory issues, trade restrictions, and other factors could all result in disputes in the oil and gas industry. Individual foreign parties are more frequently included in contracts in the oil and gas sector. It could be a private person, a state-representing organisation, or even a NOC. Another common reason for dispute is confidentiality. So what happens is the geologist only share to the market some specific prospects. This process requires a confidentiality agreement. If the lesser expect to know all the details it may cause a breach of agreement.
Application of ADR in Oil and Gas Disputes
Once the parties have decided to go for arbitration as the way of dispute dispute resolution it is very important to have an ‘Arbitration Clause’ in the lease. This is the first and foremost requirement in order to resolve future disputes.
In India, the oil and gas disputes are regulated by PNGRB Act under section 12, 13, 15 and 19. However arbitration act like an exception to PNGRB in case of Revenue Sharing Contracts and when the parties have an existing arbitration clause then Arbitration and Conciliation Act, 1996 becomes applicable. Although the arbitration clause in the contract establishes the right to have disputes arbitrated, the clause will generally incorporate a set of rules that establish the details for how the arbitration will be conducted. Once the decisional/non-decisional categories are established, it is often helpful to further classify possible dispute resolution alternatives by associating them with one of the following generally recognized types of dispute resolution techniques: negotiation, mediation, and arbitration.
Once an arbitration clause is retained in a contract which is valid and the dispute is within the contemplation of the clause, the court will give regards to the contract by enforcing the arbitration clause. It is therefore the general policy of the court to hold parties to the bargain which they freely entered.
The oil and gas lease parties' customary dispute resolution methods include informal negotiation and litigation. When a commercial conflict emerges, informal negotiation usually takes place, and the issue is eventually resolved. The economic facts of the dispute will frequently have an impact on the proceedings' dynamics.
International arbitration occurs outside the domestic territory because of either a clause inserted in the agreement between the parties or the cause of action that arises from a foreign element relating to the dispute or to the parties. According to the circumstances that led to a case being filed foreign or Indian law would be applicable. International Arbitration is one of the oldest judicial means to resolve international disputes arising in oil and gas sector.
Organization of the Petroleum Exporting Countries (OPEC) has also adopted the arbitration system and many permanent arbitration centres have been established due to this being the most common way of reassurance between the host country and the foreign country. OPEC and Non- OPEC countries usually form changing alliances that disrupt the market and this is why dispute resolution via Arbitration is adopted.
The Petroleum Company and the government frequently enter into a contract, for example, when the state grants a licensee/lessee permission to conduct oil exploration, oil prospecting, or oil mining, and when the government offers financial incentives in the form of a side letter or memorandum of understanding. Governments typically dislike engaging into arbitration agreements because they believe that doing so would be a derogation of their sovereign rights when dealing with interests related to the petroleum industry. However, thanks to liberalization, this barriers seems to have ended as now almost all the disputes in oil industry is resolved through Arbitration.
If the lease is not specific in granting the lessee the exclusive right for geophysical operations, then, disputes may arise from a lessor who grants, or seeks to grant, seismic exploration privileges on the leased premises to some third party, or the lessor may attempt to prevent his lessee from geophysical seismic exploration without payment of additional consideration.
The exploration, drilling, and exploitation of an oil and gas possibility can lead to a wide range of disagreements. Almost all of the interactions that take place during a prospect's exploration, development, and production phases are governed by contracts. Therefore, it follows that the creation and management of those contracts must be of the utmost importance.
Conclusion
As there are many parties and interests involved, oil and gas disputes can be complicated. Conflicts involving oil and gas suppliers, customers, contractors, and governments frequently result from circumstances that have an impact on the demand and supply of energy. In these circumstances, disputes may arise from business joint ventures with opposing interests or long-term supply agreements.
The perfect example is LNG agreements, which can lead to critical scenarios that affect the market upstream and downstream and force contractors to renegotiate or terminate their contracts. Last but not least, claims could be made against host states in accordance with bilateral and international investment treaties.
Arbitration has helped to evolve the Dynamics of dispute resolution in energy sector and it will continue to evolve that. Courts are already overburdened with disputes related to criminal and family matters and it is only beneficial for the oil producing companies to get their issues resolved in a more flexible and less time consuming way. The future of arbitration is bright in terms of oil sector.