Energy sector driving major growth in international arbitration

If a single industrial sector might be called the cradle of international commercial arbitration, it would be the energy business. Especially oil and gas. Huge, complex, international deals and long-term capital-intensive projects undertaken in foreign lands with differing cultural ethics and, frequently, political instability, are Petri dishes for disputes.

As a form of alternative dispute resolution (ADR), binding arbitration, then, is nothing new to oil companies. Virtually every major contract in the energy sector, be it oil and gas, electricity, wind or solar, now has arbitration clauses that steer disputes to that venue instead of litigation. For six decades arbitration has been the energy world's crucial and preferred path for ironing out contractual disputes, especially in international dealings. Now it's enjoying a noticeable growth spurt.

As this decade unfurls, a proliferation of bilateral investment treaties (BITS), geo-commercial shifts in energy production and consumption (hello, Asia), as well as new technologies such as horizontal drilling and hydraulic fracturing, are, as never before, generating contractual disputes and ramping up demand for arbitrators. Especially arbitrators with solid energy credentials who come from the ranks of corporate lawyers and do or did practise in the field. International oil companies (IOCs), in particular, are calling on them more frequently.

International arbitration stats in such favoured locals as London, Geneva and Paris indicate a solid upward trend in all industries, not to mention energy. In 2012, the London Court of International Arbitration (LCIA), the go-to organization for the biggest international cases despite concerns about escalating costs, handled 265 arbitrations, an 18.3 per cent increase over 2011.

Under the hearings administered by the International Centre for Settlement of Investment Disputes (ICSID), where most investor-state disputes are arbitrated, oil, gas and mining sectors account for 25 per cent of all claims. Other energy sectors, including electric power, racked up 13 per cent historically.

Arbitration offers the energy sector a suite of advantages over litigation. Companies like its finality. Decisions are binding. There are no appeals, except in rare cases where there's evidence of a serious procedural flub or bias on the part of an arbitrator during a tribunal.

Another attraction, says Vancouver lawyer Henri Alvarez, a member of Fasken Martineau DuMoulin LLP's International Arbitration Practice Group, is confidentiality. Arbitrations – except those involving disputes between investors and states under BITs – are conducted in private. Their decisions, awards and issues remain hushed. “These are often big, complex disputes that people don't necessarily want debated in the press,” says Alvarez.

Gordon Kaiser, a Toronto lawyer, sits as an arbitrator on numerous domestic and international cases with JAMS, the world's largest private ADR firm. He tacks on another motive: “One of the reasons I think there's a greater appetitive for arbitration is this is a relatively small industry.” Not in the sense of dollars, says Kaiser, but people. “The number of significant players is limited ... . The nature of the business is they have to work with each other long term. It's not like real estate, where you might be selling a building once to a buyer, and have little to do with them again.” In oil and gas, companies can have dozens of partners, or joint-venture agreements, their portfolio of partners changing frequently, and, sometimes, the governments they deal with acting crazily.

History has too often shown that kind of behaviour when a developing nation is more politically wobbly than a kid on skates the first time. When such countries find themselves sitting atop an oily trove but are unable to exploit it without the help and expertise of foreign companies, their sensibilities of justice, legal obligations and fairness can be eggshell thin.

It was a rash of sudden nationalization of oil concessions by countries such as Saudi Arabia and Libya – essentially stealing billions of dollars from energy firms – back in the 1960s and '70s that helped forge international arbitration as we know it today. Big oil quickly realized that fighting expropriations or asset seizures in a foreign country's courts was a losing proposition from the get-go. Neutral umpires on neutral turf with binding, enforceable decisions became as key to global energy development as drill pipes.

Companies “faced with operating in foreign jurisdictions,” says Kaiser, “are often nervous about the bias of national courts and are therefore resorting to international arbitration to resolve their disputes. If you go to court in a country where a company is the hometown star,” and often heavily tied in with government, “well, you know who the local court is going to favour.”

Thanks to binding agreements under such edicts as the 1958 New York Convention, which 200-plus countries have signed, arbitration decisions involving foreign parties are more enforceable in most countries than decisions in their own courts would be.

When disputes arise, the stakes are usually huge, often hundreds of millions of dollars in individual cases. Collectively, the monetary value at issue in current arbitrations (all industrial sectors) under the rules of just the ICSID exceeds the GDP of many countries, according to a recent ICSID annual report. Considered the leading arbitration institution devoted to investor-state disputes, ICSID, created by the World Bank in 1966, has more than 140 member countries and provides a procedural framework for international arbitration.

Seven years after signing it, Canada finally ratified ICSID in late 2013, the last G8 nation to do so. With energy- and mineral-hungry Asian nations increasingly eyeballing Canadian resources and contemplating more joint ventures or acquisitions in our extractive industries, the ratification will make Canada more foreign-investor friendly, say lawyers including Clarke Hunter, a senior partner with Norton Rose Fulbright Canada LLP in Calgary, who practises both litigation and ADR.

This “means if you have a Canadian-based company that invests in a project in Algeria or the Congo and is expropriated or punitively taxed, you have the right to go to an international arbitration tribunal and make a claim against the country.” It works the same way for foreign companies and states investing here, says Hunter. “If they perceive they are getting screwed by the Canadian government, they have a remedy under ICSID.”

The ICSID ratification is also likely to trigger more international arbitration business in Toronto, where both Arbitration Place and JAMS's Toronto Resolution Centre opened not long ago.

The awards from such tribunals, wherever they take place, can run into the 10 digits. In 2012, in what is the largest award an ICSID tribunal has so far assessed, US$2.3 billion (including interest) was awarded to Occidental Petroleum Corp. Arbitrators ruled Ecuador had breached the US-Ecuador bilateral investment treaty when, in 2006, the Ecuadorian government cancelled an exploration and production participation contract in the Amazonian jungle and seized Occidental assets in the country.

Pretty heady numbers (Ecuador has since filed for an annulment of the award). But don't expect episodes of Law & Order: ICSID on Netflix any time soon. Arbitration's relative businesslike civility compared to the adversarial swashbuckling of litigation would make for dry television drama.

Yet, if the public – not to mention many lawyers – are generally oblivious to arbitration, others are witnessing its dramatic growth. Houston attorney Tom Sikora certainly sees it. As counsel with ExxonMobil Corp.'s International Disputes Group, he works for the largest of the major oil companies. With 37 refineries in 21 countries, numerous operating divisions, hundreds of subsidiaries around the world and joint ventures with other companies around the planet – and the heaps of contracts flowing from all that – few companies turn to arbitration tribunals as often as ExxonMobil.

It's not only in the energy world where Sikora sees arbitration thriving. “It's on the rise globally as our commerce globalizes,” he says. But nobody has globalized like oil and gas. Or arbitrationized, to coin a word. Building an oil refinery or an upgrader can cost $5 billion and take five to 10 years to build. An LNG plant, like Chevron's proposed Kitimat LNG project in British Columbia, rumoured to have a billion-dollar price tag, can take just as long. “Mitigating legal and political risk is absolutely critical in these long-lead projects,” says Sikora. “Thus energy companies are particularly keen to turn to arbitration.”

And, as history repeats itself, we are seeing, in the first decades of the 21st century, a revival in so-called resource nationalism that was the bane of oil companies in the 1970s. As oil prices have climbed consistently higher, the bargaining power of oil-producing countries has increased as well. Some, especially in Africa and Latin America, are implementing taxes, royalties or other policies that make it uninviting for foreign oil firms to continue operating in their realms. Others directly boot out foreign companies. In 2007 ExxonMobil and ConocoPhillips abandoned their multi-billion-dollar investments when then-president Hugo Chavez nationalized the petroleum industry in Venezuela.

It was similar behaviour in the 1940s and '50s in the Middle East that eventually spawned organizations such as ISCID, the United Nations Commission on International Trade Law (UNCITRAL), the LCIA, the International Chamber of Commerce (ICC) the International Bar Association's Arbitration Committee and others providing neutral turf and stable rules for individuals, companies and states to resolve their trade and legal differences outside of potentially biased national courts.

“At the end of the day,” says Kaiser, “there are so many dollars involved in these [energy] deals that the deals won't work unless both parties can be convinced that there's a neutral forum.”

Debate continues as to whether or not arbitration costs less than litigation, and whether or not it is faster at resolving disputes. It's difficult to tell with ISCID cases, for example, because they involve several states and thus take five years on average to be resolved.

Which is quicker – arbitration or litigation – depends on jurisdiction, Norton Rose Fulbright's Hunter says. In Canada, for instance, there's an “extensive” backlog in Ontario's courts. It can take three to five years just to get a civil case heard. In Alberta, however, companies involved in domestic fracases can often get a trial more quickly than arbitration.

Hunter, for instance, had a case arise last spring, and was told he could get a trial last September — a mere four months. An arbitration tribunal in Alberta, where it could take 90 days or more just to find three arbitrators available to sit together for a tribunal date, could well take longer. “If you have a significant arbitration matter, there's a pool of top-flight arbitrators you'd think about using. And they tend to be pretty busy.” One major oil company headquartered in Calgary told Hunter it avoids arbitration at all costs. Domestically, he says, arbitration “isn't seen universally as the panacea it was once regarded as for disputes.”

When the arbitrations are investor-state matters “things slow down considerably” because of the government involvement, says Fasken's Alvarez, though, he adds, “There are efforts to speed them up and make it more streamlined and more efficient.”

The International Chamber of Commerce, the American Arbitration Association and the Hong Kong International Arbitration Centre are among those modifying their rules to induce more efficient hearings. For instance, says Alvarez, the ICC, which has the most widely used arbitral rules in the world, revised some of its rules in 2012, and now explicitly requires arbitrators and parties to “make every effort to conduct the arbitration in an expeditious and cost-effective manner.”

Participants must now outline the merits of their disputes and outline their claims earlier in the tribunal process. New rules also explicitly permit parties to use technology, including video conferencing and email (which were often used anyhow) to speed matters up. And institutions are now “pushing time limits,” says Alvarez. Some arbitral organizations have created incentives whereby those arbitrators who run speedier – though still thorough – hearings are paid a higher rate by the parties that select them.

“They monitor the arbitrators, make sure they get their rewards out quickly. There is a push now for arbitrators not to take on too much work, to make sure they are available to do the work in a timely manner,” Alvarez continues. “The problem is, these are big disputes, they are complex disputes. And parties tend to go back to the same arbitrators. They are tried and true.”

Emergency arbitration is also coming into vogue. That can provide interim relief to an aggrieved party until a full tribunal is assembled and a claim fully examined. “Before this, if you wanted an interim measure affecting a state or state-owned institution, you only had one choice and that was a state court. And many people would wonder whether that was an effective choice.”

And what about the cost of arbitration versus litigation? That's open to some debate as well, though, with its other favourable facets – confidentiality, no appeals, international enforceability – people are likely willing to pay an arbitration premium to resolve their disputes. It could be a lot.

At the end of 2012, the Organisation for Economic Co-operation and Development (OECD) held a roundtable on investor-state dispute settlement (ISDS). It found that recent ISDS cases averaged more than US$8 million in legal fees. In another case involving mass claims, parties spent nearly US$40 million on legal fees before the arbitration tribunal decided whether it even had jurisdiction to decide the case.

The main cost in arbitration isn't the arbitrators, says Barry Leon, partner and head of the International Arbitration Group at Perley-Robertson, Hill & McDougall LLP in Ottawa. “It's the cost of the lawyers handling the case, and the cost of experts. The actual cost of the arbitrators is a small proportion of cost.” According to the OECD, the largest component of an ICSID tribunal – 82 per cent – is for legal counsel and experts. Arbitrators' fees average 16 per cent of costs. And the costs paid to the arbitration institutions hover around 2 per cent.

Compared to the courts, says ExxonMobil's Sikora, “It is not true that arbitration is generally speaking cheaper or faster. It all depends on what court system you are. If you are in a sophisticated, say Western European or North American court system, it's not guaranteed at all that arbitration will be cheaper and more expeditious. It may be entirely acceptable for a North American oil company to go to court in Europe.”

But, counsels Sikora, “You always have to think who the finder of fact is going to be. If you want a finder of fact that is incredibly experienced, very capable, and very attentive to your case, you'll try to err on the side of arbitration. Because you'll hopefully have one, or hopefully three, arbitrators who are retained by the parties and who will expend a considerable amount of time and effort in making sure that the decisions they render are appropriate.”

Nevertheless, one reason in-house counsel at energy firms prefer arbitration is because duelling parties choose who sit on their tribunals — each party selects an arbitrator, then the two arbitrators select a third to chair a hearing. And in the complex world of oil and gas, hearings are generally swifter and cheaper when the arbitrators, who often come from energy law practices themselves, know their PDPs (proved developed reserves) and QCRs (quality control reports).

In most court systems, both in Canada and abroad, judges, of course, are determined by the luck of the draw. “You could wind up in an unhappy situation in court with a judge who has limited or no background or ability to adjudicate (an energy case) in terms of background. So the judge would be starting at ground zero,” says Leon, who has served as both a counsellor in arbitration and as an arbitrator. He is chair of ICC Canada and has counselled Russian, Middle-Eastern, Canadian and Latin American firms in energy-related and other commercial arbitration disputes.

Leon says common and civil law courts, wherever they may be, are typically generalist in nature and can rarely serve up judges with any real expertise in the energy industry. “And one of the things that's frustrating to parties in disputes is having to educate the judge or an arbitrator who knows nothing about what they are doing. Even if a person is quite capable, without relevant background, cases take time. And it can be quite frustrating that something of great significance is being decided by someone who doesn't understand their industry.”

On the other side of the table from the arbitrators – and it often is just a table in a hotel conference room or law office boardroom: no raised ornate benches for the deciders, no witness boxes, jurisdictional seals or flags – sit the arbitration counsel. They could be European, Canadian, North American or, increasingly, Asian lawyers. Hearings tend to the informal.

They have, says Leon, a more amicable, less adversarial air. “In arbitration, if someone is being disruptive, they can't assume they will never see that arbitrator again.” And so people on all sides tend to behave better. “There is an expectation there will be more of a business-like atmosphere. Which doesn't mean it won't be hard fought, but it's not hard fought in the same aggressive way that some court proceedings might be.”

And the presence of European counsellors or arbitrators – brought up under the less querulous civil law system – has a tendency to up the courtesy quotient. Leon recently heard a story about a cross-examination of an expert at a tribunal that included European counsel. To senior Canadian lawyers present the cross “was brilliantly done in terms of undermining the witness's credibility and reputation.” But, says Leon, “the very senior European lawyers reacted very differently and thought that it was disrespectful of the expert who was very qualified in his field, and that it was unproductive.”

Arbitration is growing not only in international energy disputes, but in domestic energy disagreements as well, though for different reasons. For one thing, “It's less about the enforcement aspects,” says Kaiser, as domestically, energy companies embroiled in disputes with other companies operating on Canadian turf can win a court decision in one province and still have it enforced in another province.

“What's happened,” says Kaiser, “is the number of disputes has increased. That relates to the general growth of the industry in this country.” The increased generation of electricity via wind and solar, and the explosive growth of shale oil and gas exploration and production due to fracking – and the partnerships, joint ventures, and investment that comes with all that – is keeping arbitrators busy. “Those three technologies have spawned off arbitration in areas that might surprise you, often dealing more with intellectual property,” than the usual contractual disputes, says Kaiser.

Landowner issues, such as the siting and location of solar and wind projects, are increasingly winding up in arbitration as well. Then there are commodity price drivers. When gas or oil prices sink unusually low or rise unusually high over extended periods of time, they can trigger arbitration reviews on long-term price contracts. That's been the case in Alberta, where, after the province deregulated its electricity market, it auctioned off complex power purchase agreements (PPAs) to buyers who then resell the electricity to the retail market. Many of those PPAs, which have a mechanism for annual price reviews, are 20-year contracts. Unexpected and ongoing low gas prices have impacted the PPAs associated with gas-powered electricity generation plants, and triggered a wave of arbitrations.

Most of the Alberta arbitrations, as elsewhere in Canada, are ad hoc affairs operating under similar provincial arbitration rules. The tribunals in these cases aren't operating under the auspices of the LCIA or other arbitration institutions. Instead, they operate under provincial arbitration rules that provide parties involved in a dispute more flexibility to design hearings to suit their particular situations.

In most of the Canadian fossil fuel industry, explains Kaiser, “the parties have a standard clause providing for arbitration under Alberta rules. [They] are quite familiar with them, happy with them. They have flexibility and they don't have to muck around and pay an [arbitration] institution and go through those extra timelines and bureaucracy.”

But, as demand for energy-related arbitration goes up, are we in danger of sucking dry the well of qualified arbitrators in Canada and internationally? Kaiser isn't worried yet. “There's a fair supply of good arbitrators. I don't think there's a real shortage.”

However, Kaiser, who has taught alternative dispute resolution courses at three law schools and gives a lecture every year as part of a course on regulatory issues for members of the Canadian Gas Association, thinks Canadian universities could be doing more to prep the next and larger generation of arbitrators that will likely be needed in years to come. “The law schools have been a little bit slow in my view to pick up on the arbitration education front. I think it's coming, though.”

Anthony Davis is a freelance business and investigative writer based in Calgary.