What's a Sovereign to Do?

The BP Spill and Investment Policy

The oil rig disaster in the Gulf of Mexico is causing significant damage to the region's environment and economy. The market value of British Petroleum has taken a drubbing. The political reverberations from the event continue to place intense pressure on the Obama White House. As the losses from the disaster mount, there are victims and villains aplenty. For oil-producing nations, however, the sheer scope and scale of the tragedy may offer a welcome bit of political leverage in the struggle to balance the often difficult relationship between sovereign government and international oil companies.

Oilfield development in industrial and emerging markets alike has long been dependent upon the capital, technology and appetite for risk of private oil companies. The sums at stake rapidly produced complex contractual relationships - and volatile political ones - between IOCs and host governments. Seeking insurance against perceived risk, Western corporations took refuge behind their home governments.

Typically, this shield was extended through bilateral investment treaties offering specific investor protections and arbitration provisions designed to safeguard the value of an IOC's investment in a foreign market. Over the years, these protections have expanded to cover even the potential - or expected - gain from a prospective investment. The net effect upon a sovereign host has been to radically limit the scope of government regulatory activity with regard to foreign investors. Indeed, IOCs operating overseas have enjoyed greater freedom of action than in their home markets. The history of international arbitration is replete with high profile examples of corporations challenging domestic regulation as unlawful expropriation - and winning judgments against host governments.

Since the enactment of the North American Free Trade Area in 1992, environmental groups in the United States have argued consistently that rights extended to Mexican and Canadian investors via the NAFTA treaty exceed those granted American entities under the US Constitution. As the US has evolved into a net importer of capital while concurrently extending its network of bilateral investment treaties worldwide, opposition to such privileged treatment for foreign investors has grown. The National Conference of State Legislatures and many state-level attorneys general have protested rights granted foreign investors by the federal government in bilateral investment and trade treaties. At long last, the enduring concerns of multiple emerging market governments regarding investment treaties were reflected in the American polity.

In 2008 Barack Obama and many newcomers to the Congress swept into office pledging to initiate an era of "Fair Trade", promising to limit benefits to foreign investors to be not greater than those guaranteed under the Constitution. Upon taking office in 2009, the Administration launched a high profile review of the existing US model investment treaty, with organized labor and environmental NGOs gaining significant access to the review process. At the same time, however, the federal government has pursued bilateral investment treaties with China, India and Vietnam that seek to preserve undiluted the investor protection and arbitration regime handed down through successive presidencies. The US has yet to reconcile the traditional desire to protect American flag investors overseas with the relatively newfound need to safeguard domestic regulatory prerogatives upon foreign investors in the home market. BP's Deepwater Horizon calamity will eventually focus the political community on this aspect of the American relationship with IOCs. The "British" in British Petroleum has not been lost on political commentators in the national media; questions of the company's seemingly freehand with US regulators has already become front page fodder in major newspapers.

Governments worldwide for whom the trade and investment relationship with the United States is vital, but who also harbor significant reservations over US investment policies, should be taking careful note. In recent years, negotiations toward bilateral trade treaties with Thailand and the United Arab Emirates foundered in large part over a rigid US stance on investment policy that favored corporate interests over regulatory sovereignty. Brazil, meanwhile, has resisted overtures from Washington seeking a bilateral investment treaty based largely on fears that Brasilia would cede regulatory authority in a deal to US corporate interests. The disaster in the Gulf of Mexico casts the well-founded concerns of foreign trade partners in a new light.

Understanding the implications of the BP oil spill for international investment policy is one thing. Capitalizing on them is quite another. But OPEC and other governments that play host to international extractive industries should evaluate the consequences of the Gulf of Mexico event for the future of their relationships with IOCs, their vulnerability under current investment treaties, and their options for improving their legal and political ability to regulate foreign corporate conduct in the energy sector.

This contribution was gratefully received from Eric Shimp - Special Advisor to UAE regarding the UAE-USA FTA Negotiations, and Senior Director, Global Business Strategy, Alston & Bird, LLP.