Oil and Gas Contract Law - Essay Example

?OIL AND GAS CONTRACT LAW Overview of Contractual Risk Management The Oil and Gas industry is certainly an industry that can be described as the heartbeat of industrialization of the world. This description best fits the industry given that it is the oil and gas industry that serves as the powering agent for most of the production based industries of the world. To this end, industrialization and the concept of industries could generally be grounded to a halt if the oil and gas industry is not well catered for. Interestingly, there are some specific industrial activities and programs within the industry that in their own means affect investment and the development of the oil and gas industry in one way or the other. These factors are even prevailing when it comes to upstream oil and gas operations. A typical example of such factors has to do with contractual risk management. Generally, contractual risk management has to do with an integrated process and responsibility of reviewing, analyzing and evaluating contractual risks of pending agreements so that once the agreements are executed, there would not have any repelling risk effects for the parties involved (Taverne, 2008, p. 32). Upstream oil and gas operations is one that is commonly plagued with series of disaster based occurrences that put upstream companies in so much risk of facing liabilities. It is in this direction that both operators and contractors, mainly the government has involved each other the signing of contracts that seek to protect the interest of all people involved. Even though on from a broader perspective, it would be seen as a great idea that there are contractual risks, the absence of an effective and efficient management system would result in a situation whereby the contract favors one side to the detriment of the other and it is for this reason that contractual risk management is always important. How the contract landscape has developed over the years Experts within the upstream oil and gas operations for various companies have said that the contract landscape has not been stable for some years now. In the opinion of a number of these experts, the contract landscape keeps changing with time. In most cases, the changes that take place in the contract landscape concentrate so much on contractual liabilities whereby there is an adjustment in the liabilities that defaulting companies pay (Gordon and Paterson, 2011, p. 232). The cause of the changes has also panned around two major factors. In the first instance, economic disposition has been identified as a strong factor that influences the contract landscape. Often times, when the market is weak in terms of falling global prices of oil, suppliers most cases become highly desperate towards their work and strive to overcome their negotiating position as they often have weaker negotiating positions at such times when the market is weak. Subsequently, oil and gas companies would be highly defensive on the liabilities involved in the contracts they enter into. Such weak markets is characterized by low revenues and profits for the oil and gas companies and so the best ways they try to stay within their means of operation is to avoid further risks including contractual risks. Apart from the strength of the market, events of increasing oil spills and other forms of upstream oil and gas accidents and disasters also affect the contract landscape. A typical example of this can be cited with the Macondo incident in the Gulf of Mexico, which resulted in several concerns from stakeholders of the type of risks that upstream oil and gas companies should be dealing. Certainly, during such times, contractors become defensive by increasing liabilities associated with prevailing risks. Role of Operators and Contractors Ideally, in the effect of contract risk, there are two major sides of stakeholders identified. These sides are operators and contractors. As expected, the operators are the upstream oil and gas companies who take up the responsibility and task of drilling and transporting oil and gas upstream for further distribution. The operators are also responsible for the creation and construction of most of the oil and gas infrastructure that we see upstream. Because of the nature of their activities, operators are often involved in the employment of a large quantum of skilled and unskilled labor that helps in the execution of the duties of the companies. The operators also engage the services of other companies and service providers who ensure that the logistical and technical needs of the companies are met. Because of the nature of their work, operators are often involved in the signing of contracts of different forms to protect their personal interests and the interests of other stakeholders who operate directly under them. For a typical situation of contractual risks management, operators often play the role of defending liabilities that are ascribed in the events of breach of the contracts. Furthermore, the operators also play the core role of critically subjecting the contracts to scrutiny through reviews, evaluation, and research and development to ensuring that once implemented the contracts will not pose any risks by avoiding all forms of legal ambiguities. On the part of contractors, they are often the stakeholders at the receiving, together with the government who play a simple role of ensuring that the oil and gas companies do not have their way against people their operations affect (Picton-Turbeville, 2009, p. 12). Contractors would therefore act as attorneys who would ensure that there is sufficient compensation in case of default. Effect of economic climate on contractual risk management The economic climate affects the contractual risk management process a great deal as it has been stressed already. Basically, the economic climate determines the posture of both operators and contractors in ascribing to details of the contracts. Most often, a very good economic climate will make the operators less defensive and the contractors more demanding and this would naturally create a balance between demand and supply for liabilities (David, 1996, p. 322). But interesting, there is other twist to a very busy economic climate for the contractor whereby the contractor become so busy that they are not able to hold a good defense of their sides of the contract. For the contractor therefore, the best moment of economic climate is when there is a general balance where both the contractor and operator can have enough time to defend their interests in contracts. A well balanced economic climate would be described as one that is not determined by an excessively increased price of oil due to global events such as a recent war between Iraq and Afghanistan. A balanced economic climate for the oil and gas industry would also not be determined by a free fall in oil prices because once this happens; it affects the contractual risk management negatively. On the part of the operator, because he earns less, he would be seeking for ways of paying less in case of defaulting. Governments and other contractors would on the other hand demand more but they cannot be assured of getting their demands met because of a poorly performing industry. Once the contractors want to be too hard on the operators, what results would be collapsing oil and gas industry and this will not be good for any one. Attempts that reduce risks in contract management Generally, contractual risk management involves “the calculated actions to reduce the severity, frequency, and unpredictability of damages, loses, and claims” (Miller, 2012, p. 32). From this perspective, it would be said that am attempt to reducing risk in contract management is an attempt that upholds and promotes the principles of contractual risk management, especially commercial contractual risk management (CRM) because CRM in itself aids in reducing the severity and losses associated with risks. As most damages in the upstream oil and gas industry are human cased disasters, they are considered as highly avoidable. To this end, most oil and gas companies reduce risks by ensuring that their human capital is well equipped to ensuring that the human resource base they present in the execution of goods and services are those that are highly skilled to avoid unpardonable mistakes. The same line of argument can be said about losses that are recorded by upstream oil and gas companies. In most cases, losses are recorded when rate of productivity cannot be match the estimated projections of companies. In this regard also, upstream oil and gas companies reduce risks in contract management by ensuring that their labor force are well motivated to deliver up to their optimum best (Taylor and Sally, 1992, p. 213). Reduction of risks of claims remains one important area in the reduction of risks in contract management as companies ensure this by keeping a highly professional legal team that becomes tasks with ensuring that the contracts that the company presents are those that are devoid of legal breaches. Some of the common activities assigned to these legal teams to perform include but not limited to identifying contractual risk management issues, evaluating contractual risk management issues, avoiding risk, reducing risk, sharing risk, monitoring and controlling risk, and finally using well-prepared contractual provisions (Miller, 2012, p. 234). The use of indemnity and exclusions provisions in contract management is one ways that most firms have reduced the risks associated with liabilities in their contract formations. Generally, an indemnity is a legal clause that makes good of a bad contractual situation or liability that is incurred by one party in the contract (Taylor and Sally, 1992, p. 210). Most often than not, oil and gas companies get these indemnity and exclusions through three major categorizations. The first is the use of liability in tort. In this provision, there is a general consensus by one party to indemnify the prevailing party against all forms of liability in tort (Miller, 2012, p. 200). It is not common to find liability in tort in the use of knock for knock principle. Breach of contract is the second means where in the dealing of any major contractual provision, one party gains the right to be indemnified if the other party who acts as an indemnitee breaches a side of his contract. Finally, there are specific situations clearly defined in contracts as and when they are suitable to both parties to ensure that in cases where contracts are breached, there would be no liabilities pushed against the offender. Key legal challenges associated with the contract review process The contract review process is a very important aspect of the entire contract risk management process because it acts as the key exercise that is needed to ensuring that the legal provisions in contracts are highly favorable for the companies involved. A critical aspect of the contract review process has been the need to avoid needless negotiations even after contracts are executed. This brings to discussion, the challenge of miscalculating liabilities and benefits. In most cases, companies do not undertake sufficient scrutiny of their contracts and thus are forced to go into further negotiations after defaulting occurs. In another breadth, it can be said that the need to go into negotiations occur because the companies become over complacent on the possibility of defaults ever occurring. For example, BP reported after its oil spill incident that the very last thing the company envisioned to ever occur to it was such degree of disaster that happened to it. In most cases, companies are advised to use pre-negotiated contracts to examine the validity and reliability of the contracts they sign in ensuring that needless negotiations will not become necessary even after defaults break loss. The use of pre-negotiated contracts gives the companies an opportunity to test their contracts and make provisions for all forms of legal loopholes. Furthermore, it is important that companies consider to a highly critical level, all standard contracts available to them to ensure where theirs would fit in best. Indeed, such standard contracts act as yardsticks for the companies to assess and evaluate their own contracts even before they are executed. Allocation of contractual liability between parties From a legal perspective, a contractual agreement is to be enacted and implemented to benefit the vulnerable side (Gones and Lockwood, 2004, p. 12). What this means is that at every point in time, the contract should be able to bring about justice by serving the interest of the most affected party. This clause is often achieved by spelling out rules of liability engagements in any given risk contract involving operations of upstream oil and gas companies. As it has been indicated already, upstream oil and gas companies do not go into business with hopes of incurring risks so that they would have to be liable to penalties. However, legal provisions have it that there must be provisions for liabilities in case there are unexpected defaults. Most often than not, for upstream oil and gas companies, the allocation of contractual liabilities is defined by the government on whose territorial waters the upstream drilling is taking place (Kasim, 2009, p. 32). This is so because the presence of the precious oil mineral is always considered to be the property of the nations involved and the nations are represented by their governments. Often times, because the oil and gas companies are considered to be profit making ventures, they are considered to have upper hands when it comes to risk contracts. To this effect, governments always allocate huge liabilities in cases of default. This trend becomes worse in situations where there are life threatening disasters. It is at such times that companies are expected to bring their negotiation skills to bare by defending the allocations that are made to them. In most of the instances however, once the allocation has to be done by a court, the court would often consider the bargaining powers of the parties at the time of drafting the contract as was in the case of Cook v Southern Pacific Trans Co. 623 P 2d 1125 (Thornsjo and Hasan, 2007, p. 21). In cases such as Huang v. D'Albor, 644 A.2d 1 (D.C. 1994), the court applied “lex loci” in determining the allocation of liabilities (Krippendorff, 2004, p. 32). Difficulties faced with the scope/limitations of clauses As far as the clauses in oil and gas contractual agreements are concerned, most stakeholders and operators have complained about major scopes of limitations that they face in the conduct of their business. In a recent research paper, several of such operators named the barrier between the sharing of liability between the operators and their legal contractors as one of the major difficulties they face with the scope of clauses (Gang, 2009, p. 121). This is so because in most cases, legal contractors are hired to do the drafting and final preparation of oil and gas contracts. As such, the contractors define the liabilities and benefits that go to benefactors in case of breach of contract provisions. Because contractors are only hired service men, they are not charged in any way to be liable for the losses that the companies make even though the prescription of liabilities is done by the contractors themselves. Indeed, this is a situation that most operators describe as ‘robbing Peter to pay Peter’ (Gadwan, et al, 2010, p. 134). In the opinion of such operators therefore, there should come a time when contractors should be made accountable for some of the losses that the companies incur in the form of liabilities. Until such a time, it will continue to be a very great difficult and challenge that a third party would define the liabilities that companies should be responsible for when those parties have no hand in feeling the effect of the losses. Implementation of force majeure in contracts to limit later exposure Due to the need of avoiding later exposures, operators are often legally admonished to implement force majeure in their contracts. Due to the nature of the oil and gas industry and the kind of risks involved in them, the implementation of force majeure are often prepared to fit the needs that arise of their operations such as natural disasters. Quite often, force majeure is implemented for weather related disasters (Gloan et al, 2009, p. 96). In some few cases, there has been force majeure to cater for cases of volcanic eruptions. But most importantly, it is important to note that force majeure will be implemented only on contract cases where the operator has no hand or control over the disaster or risk involved in the said case of contractual breach. But even this provision, there is a prevalent situation whereby most contractors and other beneficiaries on the sides of the contracts have had notions that force majeure is there to protect them rather than the operators. To this end, they become more demanding for benefits to come to them; especially in cases where operators do not take the effort in explaining to them that the force majeure is provided as an alternative dispute resolution measure (Strategic Direction, 2009, p. 53) and thus the need for there to be mutual benefits from it. The BP Deepwater Horizon Spill Case Analysis The legal and contractual litigations that arose from the BP Deepwater Horizon Spill are a relevant case study for analysis in relation to the present study. Specifically, the industrial and operational policies that arose as a result are highly relevant for other operators in the oil and gas industry in taking prudent contractual lessons from them. The very first case application from the BP case is that when the filing of lawsuits started, there were not suits only against BP as an entity but other sub-components of the company including Halliburton Energy Services, Transocean and Cameron International Corporation (Gadwan, et al, 2010, p. 96). The lesson out there is that subsidiary agencies that work for various oil and gas companies must be aware of the contractual provisions that these companies make in their contract laws so that in case of breaches, they will not be taken surprise by the liabilities they would also have to bear. Upon revision of the contracts, they should be in a position to negotiating with the companies on areas of the contract they find unappealing (Krippendorff, 2004, p. 84). In another development, BP issued a $40bn lawsuit against most of its subsidiary companies that were supposed to be in charge of safety and risk such as Transocean, Halliburton, which was responsible for cementer, and Cameron, which was responsible for blowout preventer (Gones and Lockwood, 2004 p. 64). Even though each of these companies had their own defenses, the lesson still remains that oil and gas companies should have clauses in their contracts that assign some levels of responsibilities to contractors through whose failed efforts and responsibilities, the company would have to incur liabilities. Once this happens, limitations of clauses will not be a problem for these companies. Examination of the use of standard contracts in providing fairness Following major legal contractual tussles such as the one that happened in the case of BP Oil and other related cases like Hornbeck Offshore Services LLC v. Salazar (David, 1996, p. 97) most oil and gas lawyers have called for the need to have a standard contract guiding the turn of events in cases such as oil and gas disasters. Often times, oil and gas standard contracts are issued to play three major roles and these are the roles of fairness, simplification of procedure, and assurance of uniformity (Krippendorff, 2004, p. 96). Between clients and contractors, there have mostly been complains that varying contractual provisions have made it difficult for contractors to access which is the best contract deals to take from their clients or operators. Also for the clients or operators, there have often been feelings that some contractors take unfair advantage of risks such as disasters to claim undue advantage over them. It is in this spirit that most companies in the oil and gas industry, particularly in the United Kingdom have devised the use of standard contracts to seek uniformity and redress to various issues pertaining to fairness. Recently, it was even outlined that using standard contracts reduce the processes involved in getting operational contracts and so the legal costs for contract constructions also become catered for. It is against this backdrop that oil and gas companies have formed legally mandated subsidiaries that together use uniformed standard contracts. REFERENCE LIST David M. R, 1996, Upstream oil and gas agreements: with precedents, London, Sweet & Maxwell. Gordon G & Paterson J, 2011, Oil and gas law: current practice and emerging trends, Dundee, Dundee University Press. Gones, P & Lockwood, A 2004. The Management of Contract Operations: An Innovative Approach to the Study of Para-Linear Contract Laws. Thomson Learning, London Kasim, A 2009, “Oil and Gas Management and Assessment Criteria. Impact on Contract Law” Journal of Sustainable Energy, 17(6):709-725 Krippendorff, K. 2004. Content analysis: An introduction to its methodology 2nd edition. Thousand Oaks, CA: Sage. Miller J. (2012). 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Taylor M and Sally T, 1992, and Winsor on Joint Operating Agreements, London, Sweet & Maxwell. Thornsjo D. O and Hasan N. B, (2007). Contractual Risk Management.http://www.johnson-condon.com/docs/07-01-16%20MDLA%20Seminar%20Risk%20Management%20Materials.pdf Read More