Venezuela is reeling from a multitude of woes. Vast swathes of the population have fled to neighboring countries as a humanitarian crisis flares out of control. The Venezuelan oil industry – the economy’s frail linchpin – has not escaped the morass. PdVSA, the state-owned oil company, is crippled by chronic operating mismanagement and resource nationalism.

However, political pressure is mounting for the country’s corruption-smeared leader, Nicolás Maduro. Russo-Cuban good-will and a pseudo-loyal military provide only a slim reed for him to lean on. Furthermore, Juan Guiadó – the constitutionally recognized interim president – has galvanized popular support for a democratic re-boot in Venezuela.

Fresh leadership presents a tantalizing path to foreign investment in the Venezuelan oil industry. If governance of the country can be wrested from Maduro’s suffocating stranglehold, shrewd international oil companies (“IOCs”) could be richly rewarded.

This article highlights Venezuela’s energy potential and proposes that IOCs use a tripartite contractual approach to manage its risks

The Prize: Venezuela’s Energy Potential
From an investor standpoint, three factors have converged to create a uniquely favorable set of circumstances in Venezuela.

First, Venezuela boasts the largest proven crude oil reserves in the world, with over 300 billion barrels at the end of 2017.ⁱ The geological risk of investment in this country is nil.

Second, despite its formidable reserves, Venezuela’s oil production plummeted to a thirty-year low of around 1.4 million barrels per day in 2018.ⁱⁱ Due to relatively low global oil prices and the petro-state’s extreme dependency on oil export revenues, the economy is in tatters. Consequently, the Venezuelan government may be forced to guarantee foreign investment by accepting lower royalty rates and offering IOCs a more stable tax regime.

Third, a long line of international arbitral decisions has reaffirmed the binding nature of stabilization clauses.ⁱⁱⁱ Modern forms of these contractual tools have successfully protected international investment in Latin America.

The Risk: A Need for Investment Guarantees
Resource development projects are not for faint-hearted, fair-weather speculators. They require large and risky initial outlays of capital that are recouped from revenue over time. Furthermore, oil prices are unpredictable. Therefore, an apparently profitable agreement for a host state may seem less favorable once the magnitude of extraction profits becomes clear.

Highly productive projects tempt host states to change their tax and legal regimes to garner a greater share of profits. Outright expropriation of IOC operations is not uncommon. Thus, an unstable political regime can render an IOC’s investment of time and capital worthless. An abysmal track record of nationalization in Venezuela justifies investor concerns.

The Plan of Action: A Tripartite Approach
This article proposes an antidote to political risk in Venezuela. It emphasizes three contractual components for protecting international investment: (1) modern stabilization clauses; (2) international arbitration and choice of law clauses; and (3) language that expressly binds the state government.

1. The New Face of Stabilization Clauses: Economic Equilibrium Clauses

Stabilization clauses are contractual mechanisms that protect key investment conditions, such as the tax regime. A stabilization clause can be conceptualized as a “specific commitment by the [host] country not to alter the terms of the agreement, by legislation or other means, without the consent of the contracting party.”^iv

Traditional stabilization clauses were defined by rigidity and absolutism. By comparison, economic equilibrium clauses (“EECs”) are a fresh and sophisticated form of stabilization device. This new generation focuses less on neutralizing a project from the application of newly adopted law, but rather seeks to address the economic impact of such changes. Thus, renegotiation is the defining feature of the economic equilibrium clause.

EECs are better suited to the fluctuating nature of commodity pricing. Ensuring project equilibrium is more important than simplistic legal stability. Under the new framework, disruption of the contractual status quo obliges the parties to renegotiate in good faith to restore the original balance of the agreement.

Importantly for the IOC, economic equilibrium clauses have teeth. Renegotiation failure may be reinforced by indemnification in favor of the party disadvantaged by any contractual modifications.^v This provides IOCs with the ultimate security they seek. The substantial award of damages to investors in Burlington v. Ecuador^vi in 2012 demonstrates the practical effectivity of well-drafted EECs.

2. Internationalizing the Contract with Arbitration and Choice of Law Clauses

Alone, economic equilibrium clauses do not offer a panacea for contractual instability. In order to maximize their stabilizing effects, they should be supplemented by other protections.

The purpose of internationalizing a contract is to ensure that both parties are bound by a legal system over which neither has unfair influence.vii IOCs should negotiate to secure neutral international arbitration in the case of any dispute arising out of a contract in Venezuela. The International Center for Settlement of Investment Disputes could facilitate this.

Likewise, international law is not necessarily controlling in disputes arising out of production sharing agreements. Therefore, in order to bolster stabilization clauses, IOCs should also include express choice of law clauses in their contracts with Venezuela. By specifically indicating which international regime applies, the parties agree to remove the contract from the domestic forum. This guarantees the international validity of the stabilization clauses. Furthermore, an IOC should also require that the venue for deciding any dispute be outside of Venezuela. This helps to prevent any possibility of local interference with the conduct of the arbitration.

By combining an international arbitration clause with an international choice of law clause and specifying a venue outside of Venezuela, an IOC can secure neutral international arbitration and the application of the rules of international law. This contractual formula provides the best platform for stabilization clauses and protection for due process.

3. Making the State a Party to the Contract

Modern production sharing agreements are usually contracted with a state entity, such as a national oil company, rather than the state itself. In Venezuela, PdVSA controls the state’s natural resource reserves.

The goal of stability mechanisms is to maintain the economic equilibrium of a contract and to “keep IOCs whole should a government enact new laws or regulations” that are inconsistent with the terms of the agreement.^ix However, in Venezuela, if the IOC fails to bind the state directly, it will be limited to pursuing a claim of breach of contract against PdVSA. In such a case, the Government of Venezuela could alter or annul a contract with impunity by legislative fiat.^x Binding the state from the outset is a much better approach.

Conclusion

As global players tighten the screws on the Maduro regime and domestic conditions worsen, Venezuela presents a unique opportunity for IOCs. They should prepare to negotiate stable production sharing agreements with the Latin American hydrocarbon giant.

Individually, the contractual devices advocated here are not novel legal developments. However, if combined as this article proposes, and applied to the Venezuelan context at this critical juncture, they have the potential to radically stabilize foreign investment.

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ⁱOPEC Share of Crude Oil Reserves, ORGANIZATION OF THE PETROLEUM EXPORTING COUNTRIES, https://www.opec.org/opec_web/en/data_graphs/330.htm (last visited Feb. 21, 2019).
ⁱⁱVenezuela, U.S. ENERGY INFORMATION ADMINISTRATION, https://www.eia.gov/beta/international/analysis.php?iso=VEN (last visited Feb. 21, 2019).
ⁱⁱⁱSee Lena Goldfields Arbitration, Annual Digest of Public International Law Cases (H. Lauterpacht ed. 1929-1930); Saudi Arabia v. Arabian American Oil Co., 27 I.L.R. 117 (1963); Sapphire International Petroleum Ltd. v. National Oil Co., 35 I.L.R. 136 (1967); BP Exploration Company Ltd. v. Government of the Libyan Arab Republic, 53 I.L.R. 297; Libyan American Oil Co. v. Government of the Libyan Arab Republic, 62 I.L.R 140 (1977); Texaco Overseas Oil Petroleum Co./ California Asiatic Oil Co. v. Government of the Libyan Arab Republic, 53 I.L.R 389 (1979); AGIP v. Popular Republic of Congo, 21 I.L.M 726 (1982); Government of the State of Kuwait v. American Independent Oil, 21 I.L.M. 976 (1982); Burlington Res., Inc. v. Republic of Ecuador, ICSID Case No. ARB/08/5 (2012).
^ivMargarita T.B. Coale, Stabilization Clauses in International Petroleum Transactions, 30 DENV. J. INT’L. & POL’Y 217, 222 (2002)
^vAlisher Umirdinov, The End of Hibernation of Stabilization Clauses in Investment Arbitration: Reassessing its Contribution to Sustainable Development, 43 DENV. J. INT’L L. & POL’Y 455, 468 (2015).
^viBurlington Res., Inc. v. Republic of Ecuador, ICSID Case No. ARB/08/5 (2012).
^viiMichael E. Dickstein, Revitalizing the International Law Governing Concession Agreements, 6 INT’L TAX & BUS. L. 54, 68 (1988).
^viiiThomas J. Pate, Evaluating Stabilization Clauses in Venezuela’s Strategic Association Agreements for Heavy-Crude Extraction in the Orinoco Belt: The Return of a Forgotten Contractual Risk Reduction Mechanism for the Petroleum Industry, 40 U. MIAMI INTER-AM. L. REV. 347, 357 (2009).
^ixJ. Nna Emeka, Anchoring Stabilization Clauses in International Petroleum Contracts, 42 INT’L LAW. 1317, 1327 (2008).
^xSee Thomas W. Waelde, George Ndi, Stabilizing International Investment Commitments: International Law Versus Contract Interpretation, 31 TEX. INT’L L.J. 215, 265 (1996).