The Uproar Surrounding Petroleum Contract Renegotiations

The prestigious Oxford Institute for Energy Studies, in its most recent newsletter, Oxford Energy Forum, published an article by Curtis Chairman George Kahale, entitled "The Uproar Surrounding Petroleum Contract Renegotiations." The article is posted here.

Introduction by the editors of the newsletter:
There are a number of fundamental issues that characterise the international petroleum industry. Their relative importance varies according to the interests of the different parties that constitute the industry. A private oil company will hold different views than a national oil corporation on what really matters; producers and consumers, or exporters and importers stand in different places on issues of interest. In this Forum a number of international authorities address some of these topics, sometimes shedding light on an obscure aspect but always assessing their import.

Two important oil problems – (a) the relationship between host countries and the foreign oil companies seeking investment access to upstream oil (or gas) reserves in their territories and (b) the peculiarities of the international oil price regime – have retained our attention.

The relationship between host and foreign oil (gas) investor is governed by contracts sometimes drafted within the framework of a petroleum law. There are instances when these agreements were entered upon at a time when the host country was politically or economically weak, or was badly advised, the consequence being a contract that put the host country at a clear disadvantage. Later the country, usually under a new political regime, realises the problem and seeks renegotiations. But some companies (if not all) reject the idea of renegotiation, or complain loudly about its unfairness. They refer to the principle of pacta sent servanda.

George Kahale, an eminent American lawyer, argues in this Forum that reference to the pacta principle does not provide complete justification for rejecting renegotiations. There are features of the oil industry that make contract renegotiations either inevitable or desirable. In brief, these are the long-term nature of oil upstream licences or agreements, the sharp volatility of oil prices, and the vital importance of oil revenues for the exporting countries. And circumstances can change radically at least once if not several times over contractual periods that usually extend over 20 or 25 years, if not longer. The sharp volatility of prices is an important change of economic circumstances for the simple reason that conditions agreed upon when oil prices were at a certain level become unacceptable when prices move to a significantly different level.

Interestingly, the attitudes of many oil countries seeking an improvement in the financial terms of their contracts are reflected in a statement of Mr Salazar, the US Secretary of the Interior, addressing an oil industry corporate audience: ‘Just as your shareholders expect you to get a fair return on your investments...the American people are asking the same of us as we manage their resources.’ What is good for the USA must also be good for other countries, a point concealed by the preferential treatment given to the superpower in many discourses.

The Kahale article, importantly, includes three case studies…

The Uproar Surrounding Petroleum Contract Renegotiations
George Kahale, III

In recent years, complaints of unfairness on the part of host states in the renegotiation of international petroleum contracts have become commonplace at conferences and seminars in both the United States and Europe. Not so often discussed are the legal issues underlying the particular cases – simply repeating the mantra of pacta sunt servanda is not a discussion. Even less attention is paid to the facts, a point which is the focus of this article. Without an understanding of the facts underlying a renegotiation, one can easily julep to the wrong conclusions, and that is precisely what seems to have been happening with alarming frequency on the conference/ seminar circuit, where conclusions are too often drawn from incomplete information derived from press releases or press reports.

Background 

This recent period is not the first time that the petroleum industry has provided the setting for political, economic and legal struggle.  The same was true in the 1970s, when the principle of Permanent Sovereignty Over Natural Resources[1] was trumpeted as loudly as pacta sunt servanda.  A wave of nationalisations gave rise to a series of arbitral decisions that would be cited throughout the coming decades, even to this day.[2]  When circumstances changed radically, the industry again became the incubator for what has been dubbed a new wave of ‘resource nationalism’.

What is it about the petroleum industry that seems to always place it in the eye of the storm? Here are some contributing factors.

First, upstream licences or agreements tend to be long-term in nature.  It was not uncommon for concessions granted in the 1950s to have a term of 50 years or longer.[3]  Production sharing agreements, the next generation of upstream contracts that became popular in many oil-producing countries when concessions fell into disrepute, were anywhere from 25 to 40 years in

length.[4]  Agreements of such duration tend to undergo fundamental changes at least once in the course of their life.

Second is the volatility of the price of the resource.  In the 1970s, the oil shock sparked by the Arab oil embargo was followed by another extraordinary price rise at the end of the decade.  The 1980s saw the market flooded with oil as Saudi Arabia increased production and market share with netback pricing.  The price of oil plummeted to less than $10 a barrel, and stayed relatively low throughout the 1990s, averaging around $18 per barrel for the entire decade.  In March 1999, the cover story of The Economist argued that the price could hover around $5 for some time.

Starting in 2004, the price environment again changed dramatically, averaging around $40 per barrel that year.   The seemingly endless upward spiral continued in the succeeding four years, with the price shooting right through the $100 per barrel barrier and reaching a peak of almost $150 per barrel in July 2008.  Given this kind of structural change in the petroleum markets, it is not unusual to see adjustments in contractual terms or fiscal regimes to take account of the changed circumstances.

Third, the economic importance of the petroleum industry to host countries cannot be overstated.  With the stakes that high, a mistake in petroleum policy can have devastating consequences for the host state concerned.  That is why matters relating to the petroleum industry tend to be considered matters of public policy in those countries.

Fourth, the best-known renegotiations and industry restructurings of the last five years have involved upstream contracts entered into in the 1990s, when the price of oil was a fraction of what it was to become and when privatisation was in vogue.  The Soviet Union had just collapsed and the prevailing attitude was that everyone would flourish from private ownership and exploitation of natural resources.  In that environment, many long-term agreements that were very unfavourable from the host country’s standpoint were concluded, agreements that invariably led to trouble as circumstances changed and the anticipated benefits of privatisation did not materialise.

“In recent years, complaints of unfairness on the part of host states in the renegotiation of international petroleum contracts have become commonplace.”

Finally, many of those contracts were not only economically indefensible, but they also purported to cede control over petroleum operations to private parties, often in a manner that raised serious legal issues going to the heart of the contracts.  Ownership of petroleum in the subsurface typically is conferred upon the state by constitutional mandate in host countries, and in some cases the political sensitivity of control over the hydrocarbon sector is at least as important as the legal issues raised by such constitutional provisions.  This explains the propensity to create new forms of contracts that pass constitutional muster and can withstand the political heat that often accompanies long-term contracts involving foreign, or any private, participation in the oil industry.  The proliferation of service’ contracts, in which the service contractor never acquires title to the oil produced, is attributable mainly to the perceived need to reconcile the desire to attract private investment with the legal and political constraints standing in the way of achieving that objective.

All this has led to contract renegotiations, and in some cases complete national industry restructurings, in the last few years.  In many countries, this has involved fundamental issues of structure and governance; all cases involved adjustments in government take.

Host countries that have taken measures in this direction include Algeria, Bolivia, Canada, China, Ecuador, Kazakhstan and Venezuela, all of which imposed new taxes and royalties on production, exports or windfall profits.  Bolivia and Venezuela also mandated structural changes for all contracts in their hydrocarbons industries.  In Alberta, Canada, the provincial government announced a 20 percent increase in oil and gas royalties.  The US Government provided Congress with a report in May 2007 on the question of increasing oil and gas royalties, including a comparison of royalty rates under fiscal regimes around the world, in response to concerns that government take was not keeping pace with record oil company profits.  Oil executives were called before Congress to defend windfall profits, and Sarah Palin’s Alaska collected billions in additional revenue from a new windfall profits tax.  The attitude of many governments is reflected in the following statement of US Secretary of the Interior Salazar to an oil industry audience last year:

Just as your shareholders expect you to get a fair rate of return on your investments and to be wise stewards of your balance sheets, the American people are asking the same of us as we manage their resources. . . .

That means we are going to take another look at royalty rates.  It means that tax breaks that are no longer needed, and which the American people can’t afford, will disappear.[5]

Three Case Studies

Three of the best-known renegotiations or industry restructurings of the last few years involved the operating service agreements (convenios operativos) in Venezuela, the gas production contracts in Bolivia, and the renegotiation of the world’s largest production sharing agreement, the one covering the Kashagan field in Kazakhstan.

In Venezuela, approximately 500,000 barrels per day were being produced under the operating service agreements, which were supposed to be pure service contracts.  The 1975 Law Regulating the Industry and Trade of Hydrocarbons did not allow, except in certain cases approved by Congress, any private participation in production.  Service contracts were allowed for basic services, such as drilling and seismic survey, but these were supposed to be pure service contracts, not contracts mimicking production sharing agreements that effectively granted the contractors a participation in the business.

The Venezuelan operating service agreements, although structured as service contracts, were in substance anything but pure service contracts.  They ceded control over petroleum operations in huge areas for 20 years, and compensation was based on the volume and value of production.  Many of the service providers were in effect senior partners in the business, on average taking more than half the value of production.  In some cases, the state company actually lost money for each barrel of oil produced, after accounting for the royalty owed to the State.  Making matters worse, the contractors, claiming to be only service providers, argued that they were subject to the non-oil income tax rate of 34 percent rather than the rate applicable to oil producers, 50 percent.

In April 2005, the Venezuelan Government intervened to require migration of the operating service agreements to the new structure of mixed company (empresa mixta) under the 2001 Organic Hydrocarbons Law, and 30 out of 32 contracts were successfully migrated over a one-year period.  The other two resulted in negotiated settlements.  The new mixed companies emerging from the migration of the operating service agreements are all subject to combined royalties and special advantages (ventajas especiales) of 33 1/3 percent, as well as the 50 percent oil income tax rate.  A special assessment for extraordinary prices also applies when the price of crude oil exceeds $70 per barrel.  Apart from the fiscal regime, a state company is by law the owner of at least 60 percent of the shares of each of the new mixed companies.  Basic minority protections are included in the by-laws, but the legal issue of control has been resolved.

Turning to Bolivia, we again hear a lot of talk about resource nationalism, but little about the facts of the old agreements.  Prior to 2005, contractors were taking 82 percent of production from Bolivia’s giant gas fields, paying only an 18 percent royalty.  This was after all investment that had long ago been recovered.  The contracts had never been approved by Congress, as appeared to have been required by the Constitution.

By 2005, the situation had become untenable.  A new Hydrocarbons Law was enacted in May of that year, imposing a 32 percent tax on the gross value of hydrocarbons (Impuesto Directo a los Hidrocarburos) in addition to the 18 percent royalty, thereby reducing the private party’s share to 50 percent.  The Hydrocarbons Law also provided a six-month period for migration of all existing contracts to one of the new legally sanctioned forms of contract.  That six-month period expired with no progress on the migration.

On May 1, 2006, the new administration again nationalised the industry, granting another six-month period for the conversion of the old contracts.  While the new operating contracts were being negotiated, the state company was given a provisional 32 percent share, reversing the old 18/82 split to 82/18.  Six months later, all of the contractors executed the operating contracts, which are structured as service contracts with the service providers receiving remuneration in cash, not oil.

The third case study is the renegotiation of the PSA covering the world’s largest discovery in three decades:  Kashagan in Kazakhstan.  There the heart of the problem was the concept of cost recovery, under which a large percentage of production, known as ‘Cost Oil,’ is allocated off the top to the contractors to recover their costs.  In the case of Kashagan, that percentage was 80 percent.  After allocation of that 80 percent to the contractor, the remaining production, known as Profit Oil,’ was allocated initially 90 percent to the contractor and 10 percent to the State, a ratio that was eventually supposed to change in favour of the State based on a set of complicated triggers set forth in the agreement.  Until then, the contractor would continue to receive 80 percent of the Cost Oil and 90 percent of the Profit Oil, or 98 percent of total production.

Despite what many feel is a textbook alignment of interests in a contract including such cost recovery provisions, experience shows that this structure is often a recipe for disaster, and that is exactly what happened in Kashagan.  Overall costs of the project increased by more than 100 billion dollars, and production, originally scheduled to start in 2005 or 2006, now is scheduled for 2012.  The net result was that in the world’s largest discovery in recent times, which is expected eventually to produce 1.5 million barrels per day, the state would have received a grand total of only 2 percent of the oil produced for at least the first decade of production, not including the relatively small participation of a subsidiary of the national oil company in the contractor consortium.  That was obviously an unacceptable situation, which most people with knowledge of the facts fully recognised.  In the renegotiation, the national oil company’s subsidiary doubled its stake in the project, a new priority share’ was allotted to the Government off the top, and new cost and schedule control mechanisms were introduced to help guard against future cost increases and delays.

What lessons can be drawn from these experiences?

First, bad deals spell trouble.  The worse the deal, or the more imbalanced the deal, the more likely it is to be renegotiated.  That goes for both sides.  One might say that the best form of stabilisation is an equitable deal.

Second, don’t believe everything you read in the papers.  Most of the renegotiations or industry transformations have ended in success, which says something about the reasonableness of the processes.  The objective has not been to exclude private participation from the petroleum industry or to make it economically non-viable, but rather to put it on a sound legal and economic footing.

Third, most renegotiations take place without adversarial proceedings, another indication that reason tends to prevail on both sides.  There is a school of thought that favours adversarial proceedings, mainly arbitration, as a negotiating tactic, but the wisdom of using that tactic would not appear to be borne out by experience.

Finally, terms such as resource nationalism’ are an oversimplification of what has been happening on the ground and are no substitute for informed analysis of both the facts and the legal issues underlying the major renegotiations of the last five years.

---

[1] Declaration on the Establishment of a New International Economic Order, G.A. Res. 3201(S-VI) U.N.Doc. A/ RE’S/S-6/3201 (1974); Charter of Economic Rights and Duties of States, G.A. Res. 3281 (XXIX), U.N. Doc. A/RES/29/3281.

[2] Libyan American Oil Company (LIAMCO) v. The Government of the Libyan Arab Republic, Award dated April 12, 1977, 20 INTERNATIONAL LEGAL MATERIALS 1 (1981); BP Exploration Company (Libya) Limited v. Government of the Libyan Arab Republic, Award (Merits) dated August 1, 1974, 53 International Law Reports 331 (1979); Texaco Overseas Petroleum Co. and California Asiatic Oil Co. v. Government of the Libyan Arab Republic, Award on the Merits dated January 19, 1977, 17 International Legal Materials 1 (1978); In the Matter of an Arbitration between the Government of the State of Kuwait and The American Independent Oil Company (Aminoil), Award dated March 24, 1982, 21 International Legal Materials 976 (1982).

[3] See, e.g., Libyan Petroleum Law of 1955, Article 9(4) (“Concessions shall be granted for the period of time requested by the applicant permitted provided that such period shall not exceed fifty (50) years.  A concession may be renewed for any period such that the total of the two periods does not exceed sixty (60) years.”).  Thomas W. Waldo, Revision of Transnational Investment Agreements:  Contractual Flexibility in Natural Resources Development, 10 Lawyer Of The Americas 265 (1978), pp. 265, 279 (“Traditional petroleum concessions in the Middle East often had a duration of up to 99 years.”).

[4] Concessions fell into disfavour not merely for economic reasons, but because they appeared fundamentally inconsistent with notions of sovereignty.  They granted international oil companies control over petroleum operations, title to production, and control of the marketing of crude oil.  Production sharing agreements did not have the stigma associated with concessions because the national oil company was usually a party, receiving a share of production and exercising at least nominal control over operations through approval processes for work programs and budgets.  The reality did not always conform to the theory, as became evident from some well-publicized cases.

[5] Department of the Interior News Release, March 19, 2009, “Salazar Addresses the American Petroleum Institute’s Board of Directors” (http://www.doi.gov/archive/news/09_News_Releases/031909.html).

Read More...

Focus on Labor Law: Fixed-Term Employment Contracts

For most companies, entering into contracts that are well drafted and carefully negotiated is key to carrying out their business smoothly and successfully. Often, some of a company’s most important contracts are those with its own employees.

Employment contracts can be of indefinite duration or for a fixed term. As this article discusses, while employment contracts are typically of indefinite duration, fixed-term contracts can offer companies distinct advantages in some cases.

Employment Contracts of Indefinite Duration

In the Sultanate of Oman, as in other countries, employment contracts are typically entered into for an indefinite duration. This embodies the company’s and the employee’s shared good-faith intention to form a lasting relationship in which the employee is committed to the company, and the company is committed to the employee for the long term.

The difficulty for the company can be that, if the employment relationship sours or the economic viability of the business turns down, terminating an employee may often require more than simply providing the required notice. (The Omani Labor Law specifies that the notice period shall be a minimum of 30 days for workers employed on a monthly basis, or a minimum of 15 days for all other workers. The Labor Law further provides that if an employment contract specifies a longer notice period than the statutory minimum, the longer notice period specified in the contract shall apply). Beyond giving the required notice, companies may often find themselves facing unfair dismissal suits by the terminated employee.

There are a number of ways that the company can successfully defend against an unfair dismissal suit. If the employee has committed acts considered by the Omani Labor Law to be gross misconduct acts – including using a false identity, intoxication or assault at the workplace, or heavy absenteeism – the company may terminate the employee without having to pay damages (indeed, the Omani Labor Law provides that in the specified cases the company need not provide notice or pay end-of-service gratuity either). Furthermore, companies often succeed in defending against unfair dismissal claims by arguing that lay-offs in a money-losing division were economically necessary.

However, notwithstanding the foregoing, Omani courts are generally inclined to be highly protective of employees. And whether they would ultimately win or lose, most companies try to minimize the risk of unfair dismissal suits being brought against them in the first place. One way to mitigate this risk is by using fixed-term contracts.

Fixed-Term Employment Contracts

The Omani Labor Law allows for employment contracts to be for a fixed rather than unlimited duration, and explicitly provides that fixed-term contracts shall be effective, stating “The contract of work shall terminate [upon] … the expiry of its period or completion of the work agreed upon.” The Omani courts, in turn, are generally very respectful of fixed-term employment contracts. While the courts often hear unfair dismissal cases brought by employees whose contract of indefinite duration was terminated, the courts are unlikely to countenance unfair dismissal claims by employees who were asked to leave the company upon the expiration of their fixed-term contracts. Although the Omani Labor Law in general favors employees, its respect for fixed-term arrangements is one of the areas where the law is protective of employers.

Although they can be used in a variety of circumstances, fixed-term contracts are naturally most useful for hiring employees that will be working on a single, discrete project with a well-defined timeframe. Fixed-term contracts may also be especially useful to foreign companies that only plan to operate in Oman for a limited period of time. By lowering the risk of unfair dismissal claims, fixed-term contracts could help to protect against overhanging liabilities that could interfere with the company’s plans to smoothly conclude its affairs in the Sultanate.

There are subtle but important nuances to the Omani Labor Law, such as the requirement that a fixed-term employment relationship must be severed at the expiration of its term, lest a continuing relationship be deemed by the Labor Law to constitute a renewal of the employment contract for an indefinite period. In light of these complexities, we recommend that you consult with legal advisors in drafting your employment contracts, particularly for senior-level employees; employment contracts are truly a field where “an ounce of prevention is worth a pound of cure.”

Read More...

Key Issues in Omani Tenancy Law

One of the most fundamental administrative priorities for a company operating in Oman is securing and maintaining local business premises. As many companies, particularly foreign companies, rent their business premises, it is important to be aware of the legal provisions governing the landlord-tenant relationship. This article summarizes some of the key features of Omani tenancy law that are most relevant to companies.

The landlord-tenant relationship in Oman is governed by Royal Decree 6/89 (as amended), the Law Regulating the Tenancy of Residential, Commercial and Industrial Premises (the “Tenancy Law”).

The Tenancy Law requires that the landlord-tenant relationship, as with other business relationships (e.g., commercial agency relationships), be recorded in a lease contract that is registered with the government. The statutory default rule is that the landlord must register the lease contract with the relevant municipality and pay the attendant registration charges. However, the parties may agree to shift this responsibility to the tenant, and the tenant in any case has the right to register the lease if the landlord fails to do so. As the Tenancy Law provides important protections to tenants, particularly in the form of rent controls and protections against eviction (see below), even when the duty to register the lease contract falls on the landlord, it usually behooves the tenant to ensure that this contract is duly registered with the municipal authorities.

One of the main focuses of the Tenancy Law is limitations on rent increases. Rent controls were featured in the Tenancy Law as originally promulgated in 1989 and were strengthened significantly by an amendment to the Tenancy Law issued in 2008 in response to sharp inflation in the Omani real estate market. Under the current Tenancy Law, landlords are not allowed to increase rent during the first three years of the lease, and rent increases thereafter may not exceed 7 percent per annum. As an exception to this general rule, the landlord may increase the rent at any time commensurate with the cost of any improvements that the landlord makes to the property at the tenant’s request.

The other key focus of the Tenancy Law relates to the term of the lease, in particular protections for the tenant against eviction. Like rent control, this featured in the original Tenancy Law but was bolstered significantly by the 2008 amendments. Under the current Tenancy Law, during the first 7 years of a business tenant’s lease (i.e., a lease for commercial, professional or industrial purposes), the lease is subject to consecutive automatic renewals unless the tenant gives the landlord notice of his intention to vacate at least three months prior to the end of the original term or the relevant renewal term. Subject to limited exceptions (e.g., misuse of the premises by the tenant or a municipal demolition order), the landlord may not terminate the lease contract or evict the tenant during this initial 7-year period.

Read More...

Judge’s Verdict: In Case of a Dispute

This article was written by Curtis partner James Harbridge of the firm’s Muscat office. It originally appeared in the Muscat Daily and is republished here with permission.

When an Omani entity signs a contract with an overseas entity, both sides are looking forward to a mutually beneficial relationship. At the time the contract is signed, neither party can imagine the possibility of being in a dispute in due course.

But the reality is that it is best to be prepared for trouble further down the line. Naturally, Omani companies will want to have their disputes heard locally in Oman’s courts. But is that always the best option?

Certainly, if the contractual courter-party is incorporated in a fellow GCC state, an Omani final court judgment is automatically enforceable against the counter-party by the courts. In such circumstances, the Omani entity may have a large monetary judgment in its favour, but how can it actually get the money if the English defendant refuses to pay up in accordance with the Omani courts’ final decision? The problem arises because Omani court judgments are not automatically enforceable in England.

First, the lawyer for the Omani company will apply to the Primary Court’s enforcement department if he or she knows that the defendant has assets in Oman or is owed any money by parties located in Oman. The enforcement department can then freeze such assets so that the Omani company can obtain the value of the judgment.

But often an overseas company will have no assets in Oman. Accordingly, the Omani company may have to file a fresh court case in England, where the final Omani court judgment may only have evidential value. In other words, the scenario can become a protracted and uncertain one.

To avoid complex, time-consuming and costly situations like this, the Omani party may, before signing the contract, look ahead and seek legal advice as to how best to ensure that there will be no enforcement issues.

One solution, in some circumstances, is for the contract to state that any dispute will be settled by the arbitration taking place in, say, Muscat. Both England and Oman are signatories to the New York Convention on arbitral awards, meaning that an arbitral award rendered in Oman should be automatically enforceable in England.

Before singing a contract, it always pays to think carefully about whether it should be governed by Omani law or a foreign law. Equally, the question of courts versus arbitration is a vital factor, as no one wants to get a court judgment which cannot be enforced. A short, pre-contract meeting with a lawyer can make all the difference as to whether you obtain an enforceable or non-enforceable decision on your dispute.

Read More...

Tendering in Oman: Practical Issues

Foreign companies wishing to tender in Oman need to understand a wide range of matters such as legal procedures, applicable government policies, the procurement guidelines, approvals required, and the implications of policy and law changes.

In this article, we highlight some issues which may impact on tendering in Oman.

• The Tender Board: Article 3 of the Tender Law provides that contracts for the supply or execution of works or transport or offers of services, consultancy studies, technical works, and purchase and lease of real estate shall be through public tenders. Certain types of contracts such as security and defence units do not go through the Tender Board; rather, these are carried out through other ministries.


• Registration: Before a foreign company may submit a bid to the Tender Board, it must register with the Tender Board. The criteria for registration depends on whether the project is for construction, supply, consultancy, or training.


• Local Representation: It is not necessary for the foreign company to have a local presence in Oman at the time of bid submission. Article 23 of the Tender Law provides that foreign companies, however, must form a local entity within 30 working days of winning the bid. Some quasigovernmental entities require foreign companies to submit their tenders through a local Omani agent, but there is no such requirement with the Tender Board.


• Standard Government Contract: Companies should be aware that the contract entered into with the government is the Omani Standard Forms and Conditions, which is based on the FIDIC standard form.


• Applicable Laws: In addition to the Tender Law, companies also should be aware of other relevant laws such as the Law of Engineering Consultancy Offices and the Foreign Capital Investment Law.


• International Treaties: The U.S.-Oman FTA and the GCC-Singapore FTA each include a dedicated chapter on government procurement.


• Oil and Gas Projects: There are additional requirements for companies wishing to bid on oil and gas projects. For example, some tenders require Oman Society for Petroleum Services (OPAL) certification.

Read More...

IWPP Finance in Oman and the GCC

After years of remarkable expansion followed by a precipitous decline in the wake of the global financial crisis, the credit market for international water and power projects (IWPPs) in Oman and the GCC appears poised for a recovery. While 2008 saw a project volume in the Middle East of about US$50 billion, nearly six months passed before the GCC saw its first IWPP financing of 2009. Bahrain’s Addur IWPP closed on 29 June, raising US$2.1 billion and bringing the overall project volume for the region to US$6.7 billion for the year. The financial crisis forced project lenders to write down the value of project debt, driving up the cost of borrowing. Further, it wiped out the secondary market for project loans as banks shunned the formerly popular practice of packaging debt in off-balance sheet vehicles. The capital that commercial banks were willing to lend came at a higher cost and decreased tenor. Whereas tenors running from 15 to 20 years at 100 bps over Libor were once common, the Addur project received debt at a tenor of eight years at 350 bps over Libor. Today, the cost of capital averages at 250 bps over Libor. The revival of IWPPs in the region has been driven by loosening credit conditions linked to new trends in IWPP finance. Specifically, banks are making increasing use of hard or soft mini-perm structures. In a hard mini-perm, debt is offered at a short tenor, in the range of seven years, requiring early refinancing. In a soft mini-perm, a longer tenor is used, but incentives are used to encourage the lender to refinance well before maturity. Another key trend has been the rising profile of export credit agencies and international development banks. Export credit bodies provide access to large amounts of relatively inexpensive capital and offer added confidence to commercial banks. Development banks have also played a key role by providing an additional source of capital and a backstop for project debt. Finally, banks have been favoring government supported projects. For instance, an IWPP with a concession or off-take agreement is a stronger candidate for financing given its relatively secure future cash flows. Additionally, governments may guarantee the obligations of state-owned parties entering into such agreements. Increasing electricity and water demand has led the government of Saudi Arabia to tender projects in form of engineering, procurement, construction (EPC) contracts, rather than build, own, operate (BOO) or build, own, transfer (BOT) contracts. Oman aims to avoid such a measure. Continuing on its program of privatization, Oman expects to see the close of a club financing of an IWPP in Salalah this year. RFPs have been released for projects at Barka, Sohar, Duqum, and Ghubrah, with another for an IWPP in Mirbat on the way. Additional projects are being studied, including a solar plant in the south of the country. In past projects, the Oman Power & Water Procurement Company (OPWP) has entered into off-take agreements. In the case of the Barka and Sohar IPPs, the OPWC will purchase the output under a 15-year agreement. IWPP finance and execution in Oman implicates a range of complex legal issues, including:

• Licensing – procurement of generation and desalination licenses and exemptions from the Authority of Electricity Regulation;
• Financing – the creation and registration of security interests in Oman, as well as review of loan and facilities agreements;
• Land Issues – entering into a concession agreement with the Government and or any usufruct agreements as may be required;
• Environmental – Compliance with the Environmental laws of Oman in coordination with the environmental authorities;
• Labor and Employment – Fulfilling the Omanisation requirements during the life of the project.

In addition, it is often necessary to put in place all the project agreements in order to obtain IWPP finance. Depending on the project, these agreements may include:

• Power and/or Water Purchase Agreement;
• Electrical Connection Agreement;
• Water Connection Agreement; and
• Gas Supply Agreement.

As the credit market revives -- and as the oil prices rebound -- Oman grows increasingly likely to meet its goal of increasing output through an ambitious program of privatization.

Read More...

FAQ: When is a Contract Formed?

When entering into contracts in Oman, complications may arise when the parties begin performing the obligations under a “contract” while the final terms are still being negotiated. What happens under Omani law when a dispute arises over the incomplete “contract”? When does a contract become a contract that is binding on both parties?

In some cases, the Oman Court (or arbitrator, if there is an arbitration clause) will be willing to impute the existence of a contract even when the parties do not have a signed agreement. For example, if an employer in Oman does not sign a written contract with his employee, the Oman Courts would still impute a contractual relationship based on evidence such as pay slips, or transfers made regularly to the employee's bank account by the employer.

In a more standard commercial context where two parties have a substantially negotiated but unsigned agreement, or even a verbal agreement that is never fully formalized in writing, the answer is not as clear. In these cases, the Oman Courts will most likely look to any documentation pertaining to the deal in deciding whether there is a contract. This is in accordance with Oman’s Commercial Code which states that contracts “may be proven by all means of so doing...”, and not only through a signed agreement.

The Oman Courts may recognize the existence of a contract, even though there is no final written agreement signed by both parties. The Court should recognize the contract based on exchange of letters, or on verbal offer and acceptance, or on the mutual trading conduct of the parties.

The ability of an Oman Court to recognize a contract is supported by Article 89 of Egypt’s Civil Code, which states that a contract is created from the moment that two persons have exchanged two concordant intentions. Article 90 of Egypt’s Civil Code adds that an intention may be declared verbally, in writing, or by conduct. The Egyptian Civil Code is the bedrock of Arabic legal justice and is heavily influential in Oman.

Nonetheless, despite the ostensible security afforded by the Egyptian Civil Code, parties seeking to prove the existence of a contract or finalize an agreement should seek legal advice. At a minimum, it is important for the party seeking to prove the existence of a contract to detail in writing to the counterparty, on a contemporaneous basis, those elements which have been agreed upon. In this respect, it is noteworthy that Oman’s Supreme Court has ruled that silence can amount to consent. In other words, uncontested letters can prove vital in dispute resolution scenarios.

Read More...