Negotiation Of Transit Pipeline Agreements : Bargaining In The Shadow Of Stability Provisions - AKİF KARACA

CURRICULUM VITAE

H. Akif Karaca graduated from Istanbul University Law Faculty in 2004. He worked as research assistant at Private International Law Department of Erciyes University Law Faculty between 2005 and 2008. He received Certificate in Private International Law from The Hague Academy of International Law, The Netherlands in 2011. He obtained his PhD degree with the thesis title of “Negotiation of Transit Pipeline Agreements: Bargaining in the Shadow of Stability Provisions” from Centre for Energy, Petroleum and Mineral Law and Policy (CEPMLP), University of Dundee, UK in 2013. He is currently working as lecturer at Marmara University Law Faculty Private International Law Department. He can be conducted through akifkaraca@yahoo.com.

The significance of transit pipelines has increased, in particular since the start of the exploration of oil and gas resources in land-locked regions such as the Caspian. The legal arrangements for transit pipelines are long-term in nature and are susceptible to unilateral changes and consequent disputes. Therefore, there is a need to stabilize the terms of these agreements. However, at the same time these agreements operate in a particular economic and geopolitical environment.   The main questions are (1) “To what extent can transit disputes be managed through the use of stability provisions as bargaining factors?” (2) “What are the determinative factors during the negotiation and renegotiation of transit pipeline agreements in the Caspian Region?” and (3) “How have stability provisions functioned in negotiated settlements of transit disputes?” This research seeks to answer these questions by taking into account the above considerations.   Transit pipelines have more often than not experienced disputes relating to the transit terms included in transit pipeline agreements. Many a times, such disputes are resolved through renegotiation by the contracting and participating parties instead of through court litigation or arbitration. Therefore, this research focuses on the concession process during the negotiation and renegotiation of transit pipeline agreements. The thesis asserts that the renegotiation of transit pipeline agreements and the concession process occur in the shadow of the law as well as the economic and geopolitical environment. In particular, they occur in the shadow of the stability provisions that are contained in the transit pipeline agreements. This research defines stability as being maintenance of the economic equilibrium of the contract. Therefore, both stabilization and renegotiation clauses are stability provisions in the context of the thesis.   Determining the bargaining factors that are effective in the concession process is essential to answer the research questions listed above. This research uses the alternating offers model of bargaining theory as an analytical framework to answer the research questions. According to the alternating offers model, there are four factors that affect the concession process. These are discount rates, risk aversion and the outside options and inside options of the parties.  These four factors have been reclassified under economic, geopolitical and legal factors in the context of transit pipelines. The legal factors are stability provisions in transit pipeline agreements and the treaty provisions that provide stability to these agreements.   In order to evaluate the value of stability provisions as bargaining factors during renegotiations, an analysis of their legal effect is required. This research adopts the methodology of doctrinal analysis of stability provisions in addition to the analysis of economic and geopolitical factors that constitute bargaining factors during renegotiations. The viability of stability provisions has been tested through assessing how they would have been used as bargaining factors in negotiated settlements in their economic and geopolitical contractual environment.   Five pipelines have been selected as case studies. These pipelines mainly originate in the Caspian Region and are directed towards Western states. This research tests the viability of stability provisions in the agreements governing these pipelines, taking into consideration the economic and geopolitical contractual environment of each pipeline in the context of the analytical framework of the thesis.   The research has found that legal factors, stability provisions (inside options), can be effective when the parties’ economic and geopolitical factors (discount rates and risk aversion) are equal and there is no preferable alternative pipeline (outside option) in the event of the renegotiation of the transit pipeline agreement. When there is a fundamental change in the economic and geopolitical contractual environment, stabilization clauses are not effective in resisting renegotiation demands by the parties and the subsequent changes in transit pipeline agreements. Therefore, flexibility should be provided through inclusion of adaptation clauses for financial terms while stabilizing the general legislative framework.

  ACKNOWLEDGEMENT..................................................................... V LIST OF MAPS     ............................................................................ XVI LIST OF ABBREVIATIONS........................................................... XVII ABSTRACT...................................................................................... XXI               CHAPTER I. INTRODUCTION:  HISTORY, CERTAIN DEFINITIONS AND THE CONTEXT OF THE THESIS       1 1.1  Historical Context of Transportation via Pipelines........................... 1 1.2  The Transit State: The Weakest Part of the Chain and        Transit Disputes............................................................................... 4 1.3 Transit Pipeline Agreements and Their  Particular Aspects.............. 8        1.3.1   Contractual Structure of Transit Pipeline Arrangements........ 8        1.3.2   Taxation............................................................................. 10        1.3.3   Transit Tariffs and Fees...................................................... 13                   1.3.3.1 Conceptual Clarification........................................ 13                   1.3.3.2 Imposition Method of Transit Tariffs.................... 14        1.3.4   Capacity and Access Rights................................................ 18                   1.3.4.1 Concept................................................................. 18                   1.3.4.2 Access to Transit Pipelines in the                                Caspian Region...................................................... 19                   1.3.4.3 Take or Pay, Ship or Pay Clauses and                                Capacity Rights...................................................... 20 1.4 Stability: Maintaining the Economic Equilibrium        of the Contract                                                                                       21        1.5       Research Questions     25 1.6 Aims and Significance of the Research......................................... 26 1.7 Methodology................................................................................. 28 1.8 Structure of the Thesis................................................................... 29   CHAPTER 2. NEGOTIATION FACTORS IN THE OPERATION STAGE OF TRANSIT PIPELINE AGREEMENTS.......................... 33 2.1 Introduction................................................................................... 33 2.2 Bargaining: Theory, Factors and Outcome..................................... 33        2.2.1   Milestones in Bargaining Theory........................................ 33                   2.2.1.1  Nash’s Game Theory............................................. 34                   2.2.1.2 Rubinstein’s Alternating Offers Model.................. 36        2.2.2   Bargaining Factors and Bargaining Outcome:                   Reaching a Deal   ............................................................... 37                   2.2.2.1 Discount Rates....................................................... 37                   2.2.2.2 Risk Aversion........................................................ 38                   2.2.2.3 Outside Options..................................................... 39                   2.2.2.4 Inside Options....................................................... 39        2.2.3   Reclassification of Bargaining Factors Based on                   Their Scope in the Context of Transit Pipeline                   Agreements......................................................................... 40 2.3 Shift of the Deal Pursuant to the Obsolescing        Bargain Model .............................................................................. 41        2.3.1   Obsolescing Bargain Concept............................................. 41        2.3.2   Obsolescing Bargain and Transit Pipelines.......................... 44        2.3.3   Cycles in the Oil and Gas Industry and Their                   Effects on Transit Pipelines: A Contributing                   Factor to Obsolescence....................................................... 45        2.3.4   Is Obsolescence Inevitable or Preventable?                   Economic, Geopolitical and Legal Constraints.................... 47 2.4  Transit Pipeline: A Multidimensional Project................................. 50        2.4.1   Economic Factors...................................................................     50                   2.4.1.1  Transit Fees and Tariffs......................................... 50                   2.4.1.2 Realizing Profit through Reaching Markets............ 51                   2.4.1.3 Approach of Transit Country to Foreign                                Investment............................................................. 52                   2.4.1.4  Approach of Pipeline Company to Existing                                and Future Investments in Transit Country............ 52                   2.4.1.5  Equity Participation of Transit Country                                in Pipeline Project.................................................. 53        2.4.2   Geopolitical Factors............................................................ 53                   2.4.2.1  Energy Security Concerns and the                                Emergence of the Caspian Region......................... 53                   2.4.2.2  Control of Energy Routes: Pipelines as a                                Geostrategic Asset for the Transit State.................. 56                   2.4.2.3 Availability of Alternative Pipelines...................... 58                   2.4.2.4 Relationship between Transit State and                                Participating Countries........................................... 59                   2.4.2.5 Relationship between Transit State, Home                                Governments of Investors and International                                Institutions............................................................. 60        2.4.3   Legal Factors...................................................................... 61                   2.4.3.1  The Relationship between Bargaining                                and the Law........................................................... 61                   2.4.3.2 The Energy Charter Treaty Framework                                and the Stability Provided by Treaty                                Provisions to Contracts.......................................... 64                                2.4.3.2.1 The Energy Charter Treaty                                               Transit Provisions................................... 64                                2.4.3.2.2 Stability Provided by the                                               ECT to Transit Contracts......................... 65                   2.4.3.3  Contractual Leverage: The Role of                                Contract Clauses.................................................... 67                                2.4.3.3.1 Applicable Law Clause........................... 67                                2.4.3.3.2 ............. Stabilization Clauses, In Particular,                                               Economic Equilibrium Clauses............... 73                                                                 2.4.3.3.3 Renegotiation Clauses, In                                               Particular, Adaptation Clauses................ 76 2.5 Conclusion.................................................................................... 78   CHAPTER 3. INTERNATIONAL TREATY FRAMEWORK OF TRANSIT PIPELINES AND THE STABILITY PROVIDED BY TREATY: THE ENERGY CHARTER TREATY EXAMPLE........... 81 3.1 Introduction................................................................................... 81 3.2 Regulation of Transit under the Energy Charter Treaty.................. 81        3.2.1   Background to the Treaty, Context and the                   Concept of Transit.............................................................. 81        3.2.2   Access to Transit and Conditions Thereof.......................... 84        3.2.3   Non-Interference Obligation............................................... 86        3.2.4   Dispute Settlement Mechanism: Binding Conciliation......... 87 3.3  Draft Transit Protocol of the Energy Charter................................. 89        3.3.1   Background and Context.................................................... 89        3.3.2   Obstacles to Ratification..................................................... 90                   3.3.2.1  Access Regulations and Right of First Refusal....... 90                   3.3.2.2 Imposition of Transit Tariffs................................. 92                   3.3.2.3 Regional Economic Integration Organisation                                Clause.................................................................... 93        3.3.3   Compliance with Transit and Swap Agreements                   and Dispute Settlement under ECT Article 27                   (inter-state arbitration)........................................................ 94 3.4  Viability of the Transit Provisions of the ECT and the        Draft Transit Protocol.................................................................... 95        3.4.1   Inefficiency of Dispute Settlement and Enforcement                   Mechanisms........................................................................ 95        3.4.2   Russia’s Draft Convention on International Energy                   Security and the Energy Charter Conference’s Road                   Map for Modernizing the Energy Charter Process............... 96        3.4.3   Arbitrability of Transit Disputes under Article 26                   Investor-State Arbitration Mechanism............................... 100 3.5 Stability Provided by the ECT Investment        Provisions to Transit Contracts.................................................... 102        3.5.1   Umbrella Clause  ............................................................. 102                   3.5.1.1  Background, Scope and Function........................ 102                   3.5.1.2 Arbitral Jurisprudence on the Umbrella                                Clause.................................................................. 104                           3.5.1.3             Clarifying the Criteria for Application of the                                Umbrella Clause.................................................. 108                   3.5.1.4 Implications of the Umbrella Clause of the                                ECT on Transit Pipeline Agreements and on                                Transit Disputes................................................... 112        3.5.2   Fair and Equitable Treatment Standard............................. 115                   3.5.2.1 Concept, Scope and Function.............................. 115                   3.5.2.2 The Content of the FET Standard in the                                Light of Arbitral Jurisprudence and Doctrine....... 119                   3.5.2.3 Observance of Contractual Obligations under the                                FET Standard and Implications of the ECT FET                                Standard for Transit Pipeline Agreements............ 122 3.6  Conclusion.................................................................................. 125   CHAPTER 4. STABILIZATION CLAUSES: FROM TRADITIONAL FREEZING CLAUSES TO MODERN ECONOMIC EQUILIBRIUM CLAUSES...............................................................................................     127 4.1 Introduction................................................................................. 127 4.2 Theoretical Context..................................................................... 128        4.2.1   Sanctity of Contract Principle........................................... 128        4.2.2   Stabilization Clause as a Tool for Political Risk                   Management..................................................................... 130 4.3 Traditional Stabilization –Freezing- Clauses................................ 131        4.3.1   Concept, Scope and Types............................................... 131        4.3.2   Arbitral Jurisprudence...................................................... 133                   4.3.2.1  Texaco v. Libya Award....................................... 133                   4.3.2.2 Liamco v. Libya Award....................................... 135                   4.3.2.3 Agip v. Congo Award.......................................... 137                   4.3.2.4 Kuwait v. Aminoil Award.................................... 138                   4.3.2.5 Duke v. Peru Award............................................ 140                   4.3.2.6  Paushok v. Mongolia, Parkerings                                v. Lithuania and Methanex v. US Awards........... 143                   4.3.2.7 CMS v. Argentine Award..................................... 144        4.3.3   The Legal Effect of Stabilization Clauses......................... 146                   4.3.3.1  The Effect of Arbitral Awards............................. 146                   4.3.3.2 The Doctrinal Views............................................ 148                   4.3.3.3 The Effect of Applicable Law............................. 149 4.4 Economic Equilibrium Clause: A New Hybrid        Tool for an Old Purpose ............................................................. 150        4.4.1   The Reasons behind the Evolution from                   Freezing to Economic Equilibrium Clauses:                   The Negotiation Context................................................... 150        4.4.2   Concept, Types and Scope............................................... 152                   4.4.2.1  The Meaning of Economic Equilibrium............... 152                   4.4.2.2 Types of Economic Equilibrium Clauses                                According to the Method of Restoration in                                the Light of Contractual Practice.......................... 153                                4.4.2.2.1 Specified Economic Equilibrium                                               Clause................................................... 153                                4.4.2.2.2 ......... Non-specified Economic Equilibrium                                               Clause................................................... 154                                4.4.2.2.3 .............. Negotiated Economic Equilibrium                                               Clause................................................... 155                                4.4.2.2.4 .................... Hybrid Economic Equilibrium                                               Clause................................................... 156        4.4.3   The Legal Effect of Economic Equilibrium Clauses......... 156 4.5 Environmental and Human Rights Exemptions........................... 161 4.6 Conclusion.................................................................................. 164     CHAPTER 5. THE QUEST FOR STABILITY FROM THE OTHER END: APPLICABLE LAW ON CONTRACT CHANGE AND CONTRACTUAL FORMS OF RENEGOTIATION........................ 165 5.1 Introduction................................................................................. 165 5.2 Causes of Renegotiation ............................................................. 166        5.2.1   Long-Term Nature of Contract: Incompleteness                   and Contingency............................................................... 166        5.2.2   Change in Economic Circumstances and the                   Particular Case of Windfall Profits................................... 167        5.2.3   Government as a Party to the Contract: The Effect of                   Geopolitics, Change in Politics and Perceived Imbalance                   of the Contract.................................................................. 170 5.3 Renegotiation without a Clause................................................... 172        5.3.1   The Role of Applicable Law............................................. 172                   5.3.1.1  Comparative Law on Contract Change................ 173                                5.3.1.1.1 English Law.......................................... 173                                5.3.1.1.2 ....................................................... US Law    176                                5.3.1.1.3 ................................................. French Law    177                                5.3.1.1.4 ............................................... German Law    179                                5.3.1.1.5 ................................................. Conclusion    180                   5.3.1.2 The Law of Treaties and Contract Change........... 182                   5.3.1.3 Customary International Law and Soft Law......... 185        5.3.2   The Reality in Practice: Forced Renegotiations                   and the Need to Legalize Renegotiation............................ 188 5.4  Contractual Forms of Renegotiation............................................ 190        5.4.1   Adaptation Clauses........................................................... 190        5.4.2   Renegotiation Clauses....................................................... 193        5.4.3   Hardship Clauses ............................................................. 194        5.4.4   Force Majeure Clauses..................................................... 197 5.5  The Procedural Aspects of Renegotiation.................................... 200        5.5.1   Triggering Events ............................................................. 200        5.5.2   The Duty to Negotiate in Good Faith................................ 202        5.5.3   Adaptation by the Arbitrator: The Role of the                   Contract and the Applicable Law...................................... 208        5.5.4   The Extent of Contract Change......................................... 213 5.6 Conclusion.................................................................................. 214   CHAPTER 6. VIABILITY OF STABILITY PROVISIONS IN THE SETTLEMENT OF TRANSIT PIPELINE DISPUTES................... 215 6.1 Introduction................................................................................. 215 6.2 Caspian Pipeline Consortium Oil Transit Pipeline........................ 217        6.2.1   Geopolitics and Economics of the Pipeline....................... 217        6.2.2   Legal Arrangements and Regulation of Transit................. 219                   6.2.2.1  Capacity Rights.................................................... 219                   6.2.2.2 Tax Exemptions and Tariffs................................ 220                   6.2.2.3 Adaptation Clause............................................... 221                   6.2.2.4 Stabilization Clauses............................................ 221                   6.2.2.5 Dispute Settlement and Applicable                                Law Clauses........................................................ 222                   6.2.2.6 Contingency Clause............................................. 223        6.2.3   Disputes on Capacity Expansion and Adaptation of the                   Agreement, and the Settlement of these Disputes............. 224        6.2.4   Assessment....................................................................... 226 6.3  The Baku-Tbilisi-Ceyhan Oil Transit Pipeline and the        South Caucasus Gas Transit Pipeline........................................... 227        6.3.1   Geopolitics and Economics of the Pipeline....................... 227        6.3.2   Legal Arrangements and Regulation of Transit................. 230                   6.3.2.1  Transit fees.......................................................... 231                   6.3.2.2 Stabilization Clauses............................................ 232                   6.3.2.3 Dispute Settlement and Applicable Law.............. 233        6.3.3   Disputes on Operating Fees, Throughput                   Guarantees and Adjustment of the Contract                   and the Settlement of these Disputes................................ 234        6.3.4   Assessment....................................................................... 235 6.4 The Kirkuk-Ceyhan (Iraq-Turkey) Oil Transit Pipeline............... 238        6.4.1   Economics and Geopolitics of the Pipeline....................... 238        6.4.2   Legal Arrangements and Regulation of Transit................. 240                   6.4.2.1  Tariffs................................................................. 240                   6.4.2.2 Adaptation Clause............................................... 241                   6.4.2.3 Dispute Settlement and Applicable                                Law Clauses........................................................ 241        6.4.3   Disputes on Tariffs, on Non-payments by the Off-taker                   Transit Country and Their Settlement............................... 241        6.4.4   Assessment....................................................................... 242 6.5 The Russia-Ukraine Gas Transit Pipeline..................................... 243        6.5.1   Economics and Geopolitics of the Pipeline....................... 243        6.5.2   Legal Arrangements and Regulation of Transit................. 244        6.5.3   Disputes on Tariffs, Gas Prices and on Non-payment by the                   Off-taker Transit Country and Their Settlement................ 245                   6.5.3.1  The January 2006 Crisis...................................... 245                   6.5.3.2 The January 2009 Crisis...................................... 248        6.5.4   Assessment....................................................................... 251 6.6  Conclusion.................................................................................. 253   CHAPTER 7. CONCLUSION.......................................................... 255 7.1 Summary of the Findings............................................................ 255 7.2 Recommendations....................................................................... 267        7.2.1   Minimizing the Effect of Geopolitics................................ 267        7.2.2   Stabilizing the Legal Regime............................................. 268        7.2.3   Adaptation of Financial Terms......................................... 269        7.2.4   Authorization of Arbitral Tribunal for                   Contract Adaptation.......................................................... 269        7.2.5   Creating a Fast, Binding and Enforceable                   Dispute Resolution Mechanism........................................ 270   BIBLIOGRAPHY  ............................................................................ 271    

LIST OF MAPS

    Map of Oil Pipelines, as of October 2007............................................. 31 Map of Gas Pipelines, as of October 2007........................................... 32 Map of the Energy Charter Treaty Contracting Parties.......................... 82 Map of Caspian Region Pipelines....................................................... 217 Pipelines Passing through Turkey                                                          290