Resource Nationalism Returns?

Myfanwy Wood:
Hello, and welcome to our Ashurst podcast series on energy and resources disputes. My name is Myfanwy Wood and I'm a partner in the dispute resolution team at Ashurst, and I'm joined by Tom Cummins, also a partner in our team. Hi Tom.

Tom Cummings:
Hi Myf.

Myfanwy Wood:
In this first episode of the series, we will explore resource nationalism. What is it, why is it currently in the spotlight, and most importantly, what can investors do to mitigate the risks of resource nationalism and protect their foreign investments? I suppose the best place really to kick it off is what are we talking about? What is resource nationalism?

Tom Cummings:
I guess, Myf, it's almost an academic umbrella term which groups together a series of situations where states take or try to take direct and increasing control of economic activity in the natural resources sectors. And of course, it's not as if you have a lawyer in an energy company running into his CEO's office and saying, "I think we're facing resource nationalism in a particular country," but the present purposes, I think it's quite a useful label to cover things like scenarios where a state imposes increased taxes on investors or increases royalties on investors, or you sometimes see a state insisting on minimum shareholdings being held by state owned companies in investments in a country. Other forms might include minimum requirements imposed by a state for the sourcing of goods or labor or services for a project. We've seen the bans on the export of unprocessed minerals by states, which means that processing of those commodities has to take place within the state rather than taking place off shore. And even, in extreme cases of course, you have states actually expropriating or seizing control of assets that belong to investors.

Myfanwy Wood:
So why now? Why would we be discussing this in a podcast in 2021?

Tom Cummings:
Yeah, good question, and of course over the course of the past year, the world economy has reeled from the effects of the pandemic. I think there are a couple of reasons why this seems a relevant topic at this time. The first is that you've got banks and financial analysts talking increasingly about an oil and commodity supercycle over the course of the next few years. Maybe they're right, maybe they're wrong about that, but you can already see record high copper prices being driven by projects that involve de-carbonization being driven by demand from Asia. And you also of course have a situation where governments in countries have been hit very hard by the pandemic. They have found it very financially challenging. So you would expect them to be looking around for ways to refill the coffers of the state finances and put those finances a better footing. And one of the obvious ways of doing that is approaching so-called or possibly deep pocketed investors and saying to them, "We want a bit more from you in order to get us back into a more fiscally secure situation."

And I think there's also a point on where this sort of thing has happened in the past. You've seen resource nationalism really occurring all over the world, but it's particularly apparent in emerging economies. When we go back in history, we can see examples in South America, some of the countries there, Southeast Asia, Central Asia, and Africa as well. Generally, I think economic circumstances, political pressures at a particular time a probably a better predictor of where you're going to see these sorts of issues than geography itself. Okay, Myf, why don't you now give us some examples of resource nationalism in the energy and resources sector?

Myfanwy Wood:
The best place to pick up, isn't it, after talking about how relevant is now, to perhaps set that to 1938, which is a really good example of resource nationalism. And I'm speaking about what happened in Mexico, when then president declared that all mineral and oil reserves found within Mexico belonged to the state and swiftly expropriated all oil resources and facilities. So that's a fairly obvious example of resource nationalism. Now bringing that a little bit closer to our era, a more recent example can be seen in Tanzania. So in 2017 and 2018, the government brought in a number of regulations which could be described as resource nationalism. So for example, it amended its mining act to include a minimum 16% free carried government interest in any mining company operating under a mining license. It also brought in a new requirement to have at least 5% ownership by an indigenous Tanzanian company in order to be eligible for the grant of a new mining license. And then it also banned the export of unprocessed minerals. So a very recent example of what could be described as resource nationalism.

Tom Cummings:
And certainly over the years we have looked at a number of cases and advised clients on instances of resource nationalism in Africa. But as we've both said, it's not confined to those geographies. You've also seen more recently in Mexico, the government there seeking to push back reforms to the hydrocarbon sector and suspend permits previously granted to private companies and give the state-owned oil company Pemex more and more control over the sector. So it's funny, in a way you started talking about Mexico and we still see similar issues, some of the pressures occurring in that country today.

Myfanwy Wood:
Probably another important point to make is that it's not always as obvious as the examples that we've gone through. So for example, at the beginning of last year, so in January 2020, Indonesia banned the export of raw nickel ores, and it's been suggested that the intention of the ban was to, amongst other things, stimulate the domestic processing of ore and force electric vehicle manufacturers to produce vehicles in the country. So quite not on the face of it obvious as a piece of resource nationalism, but when you look at the effects of what that change does, you can see how that could be described as resource nationalism.

Tom Cummings:
Yeah, I think that's a really good point. And when we were prepping this podcast, we talked about what we'd see in the actual cases where we've advised clients, and I think it's fair to say that we've tended to see more subtle forms of resource nationalism rather than the high profile outright taking of assets. Something we've seen very frequently is changes in tax regimes, changes in royalty regimes that have affected energy and resources companies. And I suspect that is one of the most pervasive forms of resource nationalism that clients in the sector face.

Myfanwy Wood:
And I think that everyone listening is really thinking let's get to the crust of it and how are we going to mitigate the risks of resource nationalism? So if we're a foreign investor thinking about investing in whatever country or jurisdiction it might be, what do we need to be thinking about?

Tom Cummings:
Firstly, from a purely legal perspective, four things come to mind, and they are investment treaty protections, protections contained in investment laws that have been enacted by host states, protections and investment contracts between investors and states, and finally political risk insurance, which is a big piece of the picture, I think, in this area. Looking at these each in turn, and we'll drill down into some of the detail, firstly, investment treaties, and these come in two forms, bilateral investment treaties, or BITs, and multilateral investment treaties, otherwise known as MITs.

And these are legal instruments entered into between states. And essentially the way they operate is that a state party to one of these treaties agrees to provide certain protections to investors from the other state party or state parties. And the protections that are provided are varied, but usually in the context of resource nationalism, the ones that we would be most likely to look at would be protection from expropriation without compensation and the obligation on the part of a host state to provide fair and equitable treatment to investors.

Crucially, these treaties typically provide for international arbitration of disputes, i.e. investors can bring claims directly against states in a neutral forum, and we'll go on to talk about that in a bit more detail. Also important to talk about host state investment laws. States may enact laws which provide similar protections to those found in treaties for investors. I think one of the challenges with those laws is that relying on the maybe much more challenging circumstances where states have abrogated those laws, renounced them and said to investors, "Sorry, those protections aren't in place anymore." There's then a question as to how investors can practically enforce their rights.

Myfanwy Wood:
Investment contracts, which is one of the points that you mentioned earlier, is similar in some ways and not in others, I suppose, but an investment contract is where an investor might conclude the contract directly with the host state or with an entity owned by the host state in the form of perhaps a license or a concession. And within that contract, it might be possible to negotiate a clause which protects the investor. So for example, the insertion of a stabilization clause, which would seek to protect the investor against any changing law or regulation which might otherwise adversely affect the investor's interest. And within that investment contract, just getting back to your point about the relevant treaties, an investor may also be advised to just make reference in the contract to any relevant treaties that are in play and just include confirmation that for the purposes of those treaties, they will be considered an investor, and that the contract would be an investment, just to make it clear that they do fit within that treaty regime and to try and bolster any claim that they might have in relation to that treaty.

And then the last point that you made with political risk insurance, and this is a big piece in the puzzle, and it just is really talking about in certain circumstances where investors can insure against risks, such as changes to law regulation. In our experience what we've seen is that insurance providers will often look to see if there are existing investment treaty protections. And ideally they would look for a subrogation clause which would allow them to step into the shoes of the investor for the conduct of any dispute with that host state. But really, as with all insurance, you just have to look around to see what's available and it will depend on the type of investment and the jurisdiction where you're investing.

Tom Cummings:
I am conscious that in answering the question we set ourselves, how do you mitigate the risks of resource nationalism? We've very much given the textbook answer, the theoretical answer as to what measures exist to mitigate those risks. I think practically speaking, there's a real point here about being forewarned if you're an investor. We have seen in the past that there are circumstances that arise that are quite good predictors of when you're going to face these sorts of issues. And I'm thinking of things like increases in commodity prices. If suddenly a commodity that is being extracted becomes lot more valuable, that may provoke a government to come along and say, "We want a bigger share of the economic benefits of this." Similarly, I think if a project becomes more profitable, that can be a trigger for resource nationalism. Often projections for developments of projects are done on quite a conservative basis, and that then drives the fiscal terms negotiated with the government.

And if those projections are exceeded, you may find that a government comes along and says, "You guys seem to be doing a lot better out of this investment than we'd anticipated. We'd quite like to share in that benefit." Somewhere where we've seen a lot of issues arise in the past has been around changes in the structure of projects. So M&A transactions involving assignments of interests or the sale of interests in companies that hold concessions or licenses. That can be an easy opportunity for states to levy capital gains tax or other forms of taxation in return for consenting to these transactions taking place. So that's a real trigger point, I think, for these sorts of issues. And then finally the political picture is important. Often a change in political regime can trigger instances of resource nationalism, and I think this is particularly the case if you have an opposition candidate or party coming into power which campaigned on a platform of being anti investor or on a populist platform. You may well be able to read the tea leaves and see that you're going to face issues in a scenario like that.

Myfanwy Wood:
The point that you make about the change in political regime we do see frequently, and I think it's also when perhaps the changing government will bring in a changing favored investors as well, and all of a sudden you could find yourself out of favor and certain actions taken against you. So I think we do see that quite frequently.

Tom Cummings:
Myf, why don't you tell us a bit more about investment treaty protections and how do they respond to resource nationalism?

Myfanwy Wood:
The important thing to keep in mind is that everything responds differently and you really need to look at everything on a case by case basis. If we look at investment treaties, for example, they do differ. However, there is a high degree of common provisions found within them. Two very common provisions that we do see is, for example, no expropriation without compensation. So if there is expropriation, then there is provision there to be compensated, and if there's no compensation, then that would trigger a breach of the treaty. Another common protection that we see is the fair and equitable treatment. And this just provides that states must be transparent, non-arbitrary, non-discriminatory, honor legitimate expectations, afford due process, avoid denial of, and avoid abusive behaviour.

I think at this point, though, we should just really put out a warning that it's important that if an investor wishes to take advantage of a protection under a treaty, that they check before investing into a particular jurisdiction whether such a treaty exists between the host state and the investor's home state, because if there is no such treaty, it actually may be possible for the investor to route its investment through a state that does have a treaty in place with the host state. `And we say this quite frequently, and we're often brought in at the point of considering investments to look at how we might structure the relevant investing company so as to take advantage of any treaty protection. But why I said there's a warning is because care must be taken with this option because structuring an investment in order to protect against the effects of an existing or a foreseeable dispute may not actually attract the protection under that treaty.

If we look at a recent example, which was the plain packaging case that Phillip Morris brought against the Australian government, the tribunal dismissed that case for abuse of process, because Phillip Morris had actually moved its ownership to Hong Kong just to take advantage of the treaty between Hong Kong and Australia, when there was a reasonable prospect of a dispute with the Australian government. Finally, what we do need to discuss is the effectiveness of all of these protections really is the enforcement of the investors' rights should the host state breach its obligations under the relevant treaty of contract. And as you said previously, Tom, this is usually arbitration. So I think here's probably a good time to maybe just talk about what an arbitration would actually look like in practice.

Tom Cummings:
The first point I make is probably there's obviously no one size fits all approach to arbitrations involving resource nationalism. You get a variety of issues, they can play out in different ways. But I think when you start looking at these issues as a disputes lawyer, you always start with your case strategy. So what is the client trying to achieve? What are the legal levers that may get them in that direction, that may help them achieve that? But there's also so much non-legal stuff that comes into play here. We're not talking about your typical contractual dispute between a couple of companies. You're talking about a highly politically charged situation. So there's analysis around the political situation in the country. Why is a particular step being taken by a government? What are the drivers of that? Are there non-legal methods that can be deployed by an investor that may be fruitful in terms of resolving that dispute?

We're talking about lobbying, we're talking about having the right contact points in governments to facilitate a dialog and to give the opportunity for investors to give presentations to explain why the picture may not be as straightforward as a government may think. And there's also, I think, a really important question about what an investor wants out of this process. It's all very well to just start an arbitration, but what is the end game? And it's certainly not always a stark question of the investor wanting compensation from government. It might well be that the need is more subtle than that. The investor may want to have the opportunity to renegotiate with the government. It may want to create an environment for a conversation to allow things to move forward in a constructive way.

There are also various things that investors can look at before they start any arbitration. There's obviously the legal analysis. How straightforward would a claim be? What are the merits of any claim against the government? If it's a stabilization clause claim of the sort we've talked about in an investment contract, what does the clause actually say? Some of these provisions can be really poorly drafted. We're talking about long-term contracts, some of them lasting decades, and there's a question about how you actually interpret and give effect to some of these stabilization provisions that might've been drafted in the 80s or 90s. And I think that really goes back to the mitigation point we were talking about earlier, Myf, i.e. if you're drafting your investment contract, think very carefully about how you would enforce a stabilization clause. Or if you're investing in a project where there is already a stabilization clause in an old contract, and you think it may not be readily enforceable, what other ways are there of mitigating risk?

I think the evidence gathering point is important as well. So at the start of the dispute, getting together the evidence that is necessary to prove the claims against the government. If you've got, say a stabilization clause in an investment contract which says a state will compensate investors if it materially changes the laws in place in the state in say, 2005, when the contract was entered into, how do you go about evidencing what the law was there, and how do you go about proving that the investor has suffered financial losses or economic harm as a result of changes since then can really be quite evidentially challenging, and that's something we've seen on a few occasions over the years.

The final point I wanted to make here is that it's really important at the start to think about what happens if you win. In a way you start with the end point first and work back from that. So if we arbitrate and we win an arbitration, then what do we do? Can you enforce an arbitration award against the state? There are all sorts of political issues that come into play. Issues of sovereign immunity. When it comes to actually enforcing against state assets. How will the government respond if you win an arbitration? Are there ways of putting pressure on the government to pay out on an arbitration award? It's quite a complicated picture and it really does pay dividends to think about that in advance. So it's not just the straightforward legal analysis. It's a far more multifaceted picture than I think some other areas of law. All right, look, Myf, I think we've covered quite a lot of ground over the course of this podcast. What's the key takeaway for our energy and resources sector clients coming out of the issues we've discussed?

Myfanwy Wood:
I think I'm going to disappoint everybody and say speak to a lawyer. I think with a lot of this stuff, it really is about thinking about it in advance before any dispute happens, thinking about where you're investing, thinking about what your investment is, and then thinking about how you might structure the investment so as to mitigate any effects of potential resource nationalism, and to really protect your rights. I suppose there's no... I would say this, but there's no real downside of doing this. I mean, it can really give you leverage in the future if things go wrong. So I think the key takeaway is plan, prepare, and think about resource nationalism before you invest in a foreign jurisdiction. With that in mind, thank you so much for listening. Please do provide any feedback into the comments box and in particular, let us know if there are any topics that you'd like us to speak about. We'd love to hear from you with respect to that. Thanks so much, Tom, and we look forward to catching up again soon.

Tom Cummings:
Thank you, Myf.

Myfanwy Wood:
Thank you for listening. This was part one in our dedicated mini series, Exploring Energy Resource Disputes. To hear more Ashurst podcasts, including our dedicated channel on all things ESG, please visit ashurst.com/podcasts. To ensure you don't miss future episodes, subscribe now on Apple Podcasts, Spotify, or your favorite podcast platform. While you are there, please feel free to keep the conversation going and leave us a rating or a review. Thanks again for listening and goodbye for now.