Petroleum Agreements Legal and Economic Issues; Ghana Case Study

Dealing with Legal and Economic Issues in Petroleum Agreements; A Case Study of Ghanaian

  1. Vague Renegotiation Clause

Parties to a Petroleum agreement may decide to incorporate a renegotiation clause allowing them to return to the bargaining table to reconsider the terms of their contract, in reaction to a certain event or set of events.[1] While renegotiation clauses are believed to be aimed at protecting the investor by providing a flexible contractual framework during the subsistence of the contract duration and particularly where the host state seeks to modify the economic circumstances by exercising their ‘sovereign’ rights, it should be understood that a renegotiation is often incorporated to be beneficial to both parties to the contract. Very rarely exclusively for the advantage of the investor.[2]

The Ghanaian Model Petroleum Agreement incorporates a renegotiation clause under Article 26 (3) and (4) of the agreement to the effect that:

“[3] Where a party considers that a significant change in circumstances prevailing at the time the Agreement was entered into, has occurred affecting the economic balance of the Agreement, the Party affected hereby shall notify the other Parties in writing of the claimed change with a statement of how the claimed change has affected the relations between the Parties….

[4] The other Parties shall indicate in writing their reaction to such representation within a period of three (3) months of receipt of such notification and if such significant changes are established by the Parties to have occurred, the Parties shall meet to engage in negotiations and shall effect such changes in, or rectification of, these provisions as they may agree are necessary.”[3]

Adib categorizes the challenges inherent in renegotiation clauses into four (4) categories namely: the vague and ambiguous definition of circumstances necessitating the duty to renegotiate; the exact contractual obligation to renegotiate particularly the question of obligation to engage in the renegotiation processes and obligation to reach a consensus; failure to define the consequences if a consensus is not reached after engaging in the renegotiation process; and the enforceability of the obligation to negotiate before an international arbitral tribunal, particularly the power of the tribunal to adjust the contract to the changed circumstances on behalf of the parties.[4]

For renegotiation clauses to be effective, it must be guaranteed that the agreement offers a clear definition of: (i) changes of circumstances (ii) what circumstance on the contract should trigger the right to call for a renegotiation; and (iii) the objective of such renegotiation.[5]

Trend however indicates that outlining clear and unambiguous definitions is difficult if not impossible. Phrases such as “a substantial change in the circumstances existing on the date of the agreement” or simply “a change of circumstances”, “disproportionate prejudice” or “substantial economical imbalance” and “removing the unfairness from the contract” or “restoring the economic equilibrium of the contract” are commonly used.[6]

The change in circumstances causing renegotiation lacks standard definition but the concept has nevertheless gained wide acceptance in practice[7] and is often embodied in renegotiation clauses. For instance, in the Petroleum production contract entered between the Government of Ghana and Shell Exploration and Production Co. provided:

“It is hereby agreed that if during the term of this Agreement there should occur such changes in the financial and economic circumstances relating to the petroleum industry, operating conditions in Ghana and marketing conditions generally as to materially affect the fundamental economic and financial basis of this Agreement, then the provisions of this Agreement may be reviewed or renegotiated…. “[8]

Bernardini argues that in order to achieve the objective of the renegotiation clause, the term ‘significant change in circumstances’ ought to be well-worded and defined in a number of ways having, as a common denominator, the conditions that the change must be such as to cause a uneven prejudice or significant disadvantage or significant economic imbalance to the interests  of one of the contracting parties or to significantly affect the economic and fiscal basis of the contract or the outcomes and consequences of which are essentially different to what was desired by the parties at the time of contracting.[9]

Bernardini further observes that the fact that the states are only obligated to engage in negotiations but not obligated to agree tends to deprive the clauses of their essence. He therefore recommends that for a renegotiation clause to be effective, it must provide a solution for what happens after renegotiations are unsuccessful.[10] In Wintershall A.G. v. Qatar case for instance, the claimant contended that the Qatar Government was in breach of the renegotiation clause which stipulated that in the event that non-associated gas was discovered in commercial quantity, it had to enter into further arrangements.[11] The tribunal concluded that no breach of the renegotiation clause since; the government was only obliged to negotiate in good faith but there was not any undertaking thereof to reach an agreement.

  1. Ambiguous Environmental Laws and Regulations

The most popular dispute over environmental laws and policies in Ghana is the incident involving Kosmos Energy after it allegedly spilled 700 barrels of low toxicity substance in its drilling fields West Cape. Consequently, the company was slapped with a Thirty-Five Million Dollars ($35,000) fine after a 5-member ministerial committee was set up to investigate the issue.[12] Upon the imposition of the fine, Kosmos officials contended that the company was not under an obligation to pay the fine as the same was “totally unlawful, unconstitutional, ultra vires and without basis.” They also argued that the Minister in charge of environmental matters lacked capacity to cause such fine to be imposed on the company.[13]

A close look at Ghana’s legislations and policy frameworks governing Petroleum exploration exposes a gap in both state and international law regimes governing oil spillage from oil platforms. There is also an apparent gap in the institutional framework to deal with issues of environmental degradation during exploration.[14] The Petroleum (Production and Exploration) Bill that is in place fails address the institutional challenge. It ought to set out clearly, the rules of engagement and organization efforts in the management of Ghana’s marine environment. It also ought to identify the lead agency or authority responsible.[15]

While the laws in place define the various offences and applicable fines they fall short of the tested valuation method or formula for calculating the right amount of compensation on establishment of liability. The manner the fine charged on Kosmos Energy for the jubilee oil spills was arrived at created doubts as to which formula was used.[16]

As a result of this gap, the investor found liable for environmental pollution may end up being charged exorbitant penalties or a penalty too low compared to the amount of damage caused by the negligent act of pollution.[17] Since the laws and policy regulations in place fail to provide a practical formula of estimating such damages, it would require the issue to be dealt with within the agreement. This could be in form of a stabilization clause by setting up a standard formula to be used in future incidents or provide for a renegotiation clause to allow parties to engage in renegotiation to come up with such figure based on case to case basis.[18]


  1. Change in Allocation of Management and Control, Lessons from Ghana-Valco Agreement.

The change in allocation of management and control can be occasioned by a number of factors. The most notable one in Ghana is the change in economic circumstances which led to renegotiation of the agreement entered into between Ghana and Valco.[19] It should be noted that investment agreements are applied in a dynamic environment and are prone to be affected by economic conditions which are unexpected at the time of execution of these agreements.[20]

Giving up a country’s sovereignty rights over resources or legislative power to investors could be prejudicial to its citizenry. Not only do some stabilization clauses interfere with a host country’s existing legislations to suit them, they also prevent them from legislation and policy enactment that could prove beneficial to the country but unfavorable to the foreign investors.

The Model Petroleum Agreement adopted by Ghana provides as follows:

“The State guarantees Contractor the stability of the terms and conditions of this Agreement as well as the fiscal and contractual framework hereof specifically including those terms and conditions that are based upon or subject to the provisions of the laws and regulations of Ghana (and any interpretations thereof) including, without limitation, the Petroleum Income Tax Law, the Petroleum Law, the GNPC Law and those other laws, regulations and decrees that are applicable hereto…and…may not be modified, amended, altered or supplemented except upon the execution and delivery of a written agreement executed by the Parties…” [21]

According to Faruque, the clause meets the threshold of an effective stabilization clause in restricting the state’s use of its administrative capacity to change the terms of the contract. It also accommodates necessary modifications and amendments done to the agreement by either party with the other’s consent.[22]

A clause of this nature aims at ensuring the stability of key terms of the agreement guarding the private party’s investment such as: fiscal legal regime, labor laws and exchange control regulations. They may at times require the State to guarantee that it will not confiscate or nationalize the investment. As such, the stabilization clause is more desirable to the investor than by the state.[23]

Though some stabilization clauses attain their objective of protecting the investors against host State’s laws, forcing the investor to pay heavily as compensation still come with growing concern. Not all the contracts achieve their aim with regard to forcing governments to abide by the terms of the agreement, because states are sovereign and are recognized under international law to use such sovereignty to govern, to attempt to stop them from performance of their legislative duties because of contractual obligations is unenforceable.[24]

Therefore, the mere act of execution of an agreement by the state is not guarantee of performance since the state can proceed to make legislations that affect the conditions of the agreement in exercise of its sovereign powers. For instance, in Parkerings vs. Lithuania the arbitrator settled that it is each State’s undeniable right and privilege to exercise its sovereign legislative power and such power should not be undermined by provisions of a contract.[25]

Stabilization however does not always have the effect of ‘freezing’ the applicability of all subsequent laws to the conditions of the agreement as this would result in the state losing its legislative sovereignty.[26] Stabilization clauses could be beneficial to either party and equally detrimental to either. They do not favor the oil companies in all circumstances. There are instances where the company may require the provisions to be modified due to changes in economic or market conditions. In such cases, ‘economic balancing’ clauses become more preferable.[27] These clauses do not freeze the laws and regulations subsequently enacted from the time of entering the contract. Instead, they contain an equilibrium provision which provides that such changes in legislation and materials should be such as not to adversely impact the economic benefits of the investors under the petroleum agreement. In this case, the state still maintains its inherent sovereign legislative and administrative power while the interests of the investors under the contract remain safeguarded.[28]

The Ghana-Valco agreement was viewed by investors, Kaiser and Reynolds, as an opportunity to gain access to massive bauxite deposits and low-priced hydropower in Africa to supplement their limited reserves in the United States.[29] Under the terms of the said agreement, the government guaranteed the investors nearly three-quarters of the hydro-energy produced from the Volta River Project at the low rate of 6.265 mills per kilowatt hour (mills/kwh) fixed for thirty years. In addition to cheap power supply, the government provided the company with other incentives such as low fees for water, port, and wharfage services, exemption from foreign exchange regulations, duty-free alumina exports and imports by the company, a ten-year tax relief, and other firm guarantees protecting the investment.[30]

In 1982 however, there were major concerns with respect to the said agreement executed in 1962. The Ghanaian public was concerned with the deal as it was viewed as a one-sided affair. The company’s monopoly over electric power left only enough power for five percent of the Ghanaian population. It also frustrated the government efforts to attract other investors because the country could not give assurance over supply adequate of energy that the investors desired.[31]

Furthermore, the rates paid by the investors to the Ghanaian government for the electric power remained too low compared to the rising energy costs occasioned by the fuel crises at the time. Weighed against revenues collected from the sale of electric power to other users of the Volta River Project, revenues collected from energy sales to Valco did not match to the quantity of energy sold to the company.[32]

The change in electric power prices, drought problems that led to low power production, the deemed technical problems in the agreement that threatened to take away the country’s sovereign rights and the concerns over inadequate safeguards against industrial pollution in the agreement were some of the areas in the agreement that the Ghanaian government wanted reviewed.[33]

Consequently, the Ghanaian government and Valco embarked on renegotiation of the agreement. Relying on the absence of review clauses in the agreement and on the principle of the sanctity of contracts, Valco opposed the intention of the government to review the agreement.[34]

Ghana’s demands included increment in the power, water, wharfage, and port rates, as well as the normalization of taxation arrangements. Other issues raised involved Ghanaian representation on the board of directors of Valco, an evaluation of the tolling terms between Valco and its shareholders and embracing of stricter environmental controls by Valco.[35]

After a series of discussions, new terms of the agreement particularly in the above areas were agreed and a draft agreement executed on 30th January, 1985 was reached.[36] Under the new terms agreement, Valco agreed to pay a base power rate of 17 mills/kwh, the available power was to be allocated according to a predetermined formula as opposed to the seventy percent allocation that Valco was initially entitled to, the company was now required to pay custom duty on materials used in production, the company now had to pay forty-six percent income tax customs duties, stamp duties, road taxes on vehicles that Valco operated outside the smelter site and other minor taxes. Finally, the clauses that purportedly threatened Ghana’s sovereignty over its natural resources were amended.[37]

The change in economic circumstances occasioning imbalance in the economic equilibrium and force majeure which affected electric power production led to the Ghanaian government pushing for more control over the manner the project to achieve mutual benefits for its people. One the other hand, Valco pleaded the principle of sanctity of contracts which would require the Ghanaian government to discharge its mandate as per the terms in the initial contract.[38]

Significant change in circumstances as a ground for reviewing the rights and obligations of the parties to an agreement has been envisaged in national legislations, international and regional treaties. However, as most of these changes are normally unexpected at the time of executing the contract and therefore makes it impossible to provide the manner in which they will be dealt with when they arise.[39]

Stabilization and renegotiation clauses are the two ways to realize the parties’ common objective to share among   them the inherent risks in a long-term contract.[40] There are certain risks that experienced parties have to deal with this kind of long-term transactions to achieve contractual stability. Therefore, these risk allocation clauses apply on occurrence of circumstances which the parties believe to be beyond the level of acceptable risk in these kinds of transactions.[41] Without a pre-determined level of such acceptable risk, the circumstances for triggering such clauses depends on the specific contractual arrangements, the parties’ interest discharging their obligations and their respective bargaining power. This is the reason stabilization clauses may have dissimilar aims and why renegotiation clauses may be triggered by a variety of different occurrences.[42]

While the stabilization clause would have the effect of preventing application of legislations and administrative policies enacted after execution of the agreement by the host state from modifying contractual terms, the renegotiation clause operates in the presence of a operates in the presence of a significant change of the circumstances outside the control of the contracting parties which occasions substantial variation of the economic equilibrium of the contract.[43]

The circumstances leading to disputes in the Ghana-Valco agreement, as shown above are that the state’s main concerns were continued exploitation of resources with low economic returns, the threatened sovereignty rights over its resources and force majeure factor with water scarcity causing low electric power production hence causing power shortage throughout the country.[44] There was hence the need to change all the above in favour of the state and the Ghanaian people. On the other hand, the company wanted the principle of sanctity of contracts to be upheld which would consequently retain the status quo.[45]

Exploration drilling for oil and gas comes with a number of risks such as the risk of dry holes or non-existence of commercially viable deposits of hydrocarbons[46]. The costs associated with drilling, finishing and operating wells have various levels of uncertainty, and drilling operations may be unfruitful due to various factors, including unforeseen drilling conditions, pressure, equipment failures, blowouts and other forms of accidents, and scarcity or delays in the procurement of equipment.[47] The Company is involved in large exploration and drilling operations offshore, especially in deep and ultra-deep waters, and in isolated areas, in environmentally-sensitive areas and other challenging contexts. In these locations, the companies generally encounter more challenging and riskier conditions and incur higher exploration costs than onshore.[48]While some of the costs are allowed to be to be deducted before declaring income to the National, Petroleum Corporation, some are not among the outlined as allowable deductions and hence the investors are left to bear them.[49]

Most of these additional costs are as a result of unexpected events and hence makes it difficult to set out how such will be dealt with at the time of preparing and executing the petroleum contracts. As such, it is advisable to incorporate cost sharing or cost deduction clauses to provide for the manner in which these extra costs are to be shared. In the alternative, parties can opt to renegotiate on case to case basis to determine how cost sharing of the extra costs is to be carried out.[50]

The other factor that leads to increased costs of production

  1. Inconsistencies in Petroleum Tax Regime

The oil and gas taxation regime of Ghana are identical to those of Ukraine and Nigeria; they are complex and display a significant amount of vagueness and contradictions.[51] Specified areas under Ghana’s Petroleum are the legal framework for taxation and revenue types, evaluation of chargeable incomes under Petroleum Income Tax Law (PITL) deductions, and withholding tax – sub-contractors and employees. Other areas are Internal Revenue Act (IRA) relating to upstream oil and gas operations (there are serious areas of inconsistencies between PITL & IRA), and the Petroleum Agreements. The rest are the Internal Revenue (Amendment No. 4) Bill, Value Added Tax as well as Customs, Excise and Preventive Service provisions.[52]

In determining rates chargeable for petroleum, there is need to distinguish between investment companies which have not completely paid off their capitalized preproduction expenditure and those who have.[53] For Ghana, with an undeveloped oil industry which aims to gain interest of the best investment companies, these rates should be considerably lower than those of countries with established oil sectors like Nigeria (85% and 65%) or the UAE where there are variable income tax systems and high rates of payment of royalties. Proper evaluation should be made to establish which tax system or a blend would better fit Ghana considering its unique circumstances.[54]

Ali-Nakyea suggests a periodical review and study of the prevailing tax and custom policy to help formulate more comprehensive petroleum policies with certainty as to the nature of tax and applicable rate.[55] To avoid the risk of overpaying taxes, in most cases, the agreement should form the final reference point for what and how much the investor is under obligation to pay through offering stability clauses which freezes the conditions of the contract during the subsistence of the contractual period. On the other hand, the state should seek to have an adaptation clause incorporation to allow the parties to modify the clauses where there are changes in the prevailing economic circumstances such as in the Ghana-Valco agreement.[56]

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