The UK Petroleum Production Licence — Is it a Contract or Regulation and Does it Matter? by Omon Anenih ABSTRACT: Although the United Kingdom government has proprietary rights to the petroleum reserves in the UK, it has turned to private companies who hold most of the financial and technical wherewithal needed for the exploration and exploitation of petroleum resources. The petroleum production licence is the legal arrangement between the government and the private company that gives effect to this symbiotic relationship. ‘The nature of the licence has been the subject of much speculation, Is it contractual or regulatory? Much importance has been placed on this qui nin evaluating the stability of the rights of the licensee under the licence. The aim of this paper is to look at the character of the production licence in order to elucidate the legal nature of the relationship between the State and the licensee, and the import of defi ing this relationship. The paper concludes that the contractual appearance of the UK production licence merely serves to conceal its truly regulatory character. It is further argued that rather than focus on the definition of the licence, attention should be paid to actual government practice, as a definition of the licence is not a panacea for the prote n of the rights of the licensee. 1. INTRODUCTIO! Petroleum development is extremely capital intensive and requires detailed expertise, advanced technology and marketing outlets, Although Governments own most of the world’s petroleum resources,’ they do not have the capacity to carry out such technical tasks as drilling wells and laying pipelines.” Consequently, many Governments are compelled to turn to private companies who hold most of the financial and technical wherewithal needed for the exploration and exploitation of petroleum resources. In order to give effect to this symbiotic relationship,’ a form of legal arrangement must be entered into, The nature of this arrangement and what it is called will differ from one legal system to another. In the United Kingdom, this petroleum development mechanism takes the form of licence. The basic law governing the development of hydrocarbons in the United Kingdom is the Petroleum (Production) Act 1934, as extended to offshore operations by the Continental Shelf Act 1964 and now consolidated in Part I of the Petroleum Act 1998.4 Under the Petroleum (Production) Act 1918, petroleum production licences were regulatory in nature and not muchdifferent than most other licences we are used to ~ dog licences, TV licences, etc. They were all administratively granted exemptions from legal prohibitions.’ However, the character of production licences changed when the 1934 Aet vested in the Crown, proprietary rights petroleum.” The new licensing regime was no longer based on the need to prohibit unlicensed exploration and exploitation of petroleum resources, but on the transfer of the proprietary rights of the Crown.” Over the years, there has been much speculation as to the legal nature of the ‘moder’ production licence. Is it contractual or regulatory? This question is of extreme significance in evaluating the stability of the licence, as it affects the predictability of the environment that the private licensee has to operate in. The aim of this paper is to look at the character of the production licence in order to elucidate the legal rature of the relationship between the State and the Licensee, and the import (in terms of protection to the private company’s rights under the li ce) of defining this relationship. ‘This paper will start by considering the form of the licence and the model clauses applicable to it, It then goes on to discuss the character of the licence, laying much emphasis on the unilateral amendments of licence terms by the government and the way these alterations undermine the contractual nature of the livenee. Arguments will also be considered which lend support to the opinion that the licence possesses a regulatory element. The fourth section of this paper deals with the practical application of the licence and considers the practical significance of labelling the licence as “contractual” or “regulatory”. At the end of this paper, it is concluded that the contractual appearance of the UK petroleum production licence merely serves to conceal its truly regulatory character. It is also argued that too much importance is attached to labelling, The focus should be on actual government practice, as a definition of the licence not a panacea for the protection of the rights of the licensee. ‘There are other i sues that follow on from the question of the character of the licence and its practical application, These include international law and European Community regulation in this area. However, due to limitations on length, these issues have been excluded from the scope of this paper.2, THE PRODUCTION LICENCE AS A CONTRACT. 2.1, The Contractual Form of the Licence. At first sight, the production lisence may appear to be a contraet. Its form is contractual, being a deed by the Minister on one side and the licensee on the other, temporarily transferring rights to private individuals in return for consideration.’ The model clauses provide that “EXCLUSIVE LICENCE and LIBERTY... to search and bore for and get petroleum” is granted in consideration for the payments and royalties to be received from the licensee.” One scholar favours the opinion that since this is the language of private contraet law, rights held under the licence are therefore contractual. Furthermore, the fact that section 6(d) of the 1934 Act’ requires the model clauses to te contained in production licences (subject o the discretion of the mi ster) is not different from standard form contracts that are now widely used. Nevertheless, the language of contract contained in the licence is not of itself sufficient evidence that the licence is in fact an enforceable contract — it may be a mere statement of intention.'' Arguably, what is of paramount importance is the substance of the licence. 2.2. The Contractual Substance of the Licence. It has been argued that not only is the licence contractual in form, it is also contractual in nature, The subject of the licence is mainly the transfer of valuable rights in retum for financial remuneration.'”. The licence evidently contains many provisions that bestow great powers of control on one party ~ the minister, over the other ~ the private company. Nonetheless, it has been submitted that this is an accepted feature of many private contracts. Although he recognised that the model clauses impart a regulatory flavour upon the licence, one learned writer maintains that this does not in his opinion, displace the essentially contractual nature of the licence.'? 2.3. Unilateral Alteration of Licence Terms. It is a general principle of contract law that the terms of a contract may only be altered with the mutual consent of parties fo the contract. However, this principle appears to have no application in relation to government contracts, since the government may in fact make such unilateral alterations, ‘The unilateral amendment of licence terms by the government has been a subject of extensive discussion. This issue is one of particular importance, for a number of reasons, Thethe power of parliament to make unilateral alterations ygle most important factor that effectively strips the licence of its contractual character and undermines the protection to the licensee that would otherwise be available under contract. Also, the most widespread fear of investors is the risk of adverse change of law.'* The ability of the government to effect subsequent changes on existing licences must be appreciated in the light of the effect it may have ‘on future investments. For these reasons, a substantial part of this paper will be focused on the issue of unilateral alterations of the licence. The much cited case of Rederiaktiebolaget Amphitrite v. The Crown’ established the principle of law that “(the Crown) cannot by contract hamper its freedom of action in matters which concern the welfare of the state,”!© The judgment of Devlin L in Com ners of Crown Land v. Page,"” clearly stipulates the position of the law with regards to the limitations on all contracts entered into by the Crown and all public authorities. According to Devlin, “When the Crown, or any person is entrusted, whether by virtue of the prerogative or by statute, with discretionary powers to be exercis for the public good, it does not, when making a private contract in general terms, undertake to fetter itself in the use of those powers, and in the exercise of its diseretion.”"* The precise scope of this iciple is controversial and unclear.’ The decisi Minister of Pensions” placed a limitation on government freedom of action. Denning, J., as he was at the time, in finding for Robertson, held that the Crown could in fact be bound by estoppels. He went on to find that the defence of executive necessity (i.e, that the Crown cannot bind itself so as to fetter its future executive action) was limited in scope and did not apply to every case.”! Thus, although the Crown may not fetter the use of future executive powers, this does not mean that all agreements entered into by the Crown or public authorities cannot create any contractual obligations. In the context of the petroleum licence, the fact that it may, and indeed has been,” unilaterelly altered by the government, does not mean that it is not a validly enforceable contract. In the space of just over a decade, the UK government made three unilateral amendments to existing licences, giving them retroactive effect.”* It has been argued that although the amended licences remain contractual in form, they cannot be so in substance, since they lack the essential feature of contract — consensus as to terms.”* However, a contrary argument put forward has been that government freedom of action exercised in this manner does not strip the licence of itscontractual character, but gives the state added powers in relation to these contracts, Professor Bowett stated that: “If there is a general principle to be applied, it is not the absolute sanctity of contraets, for no such principle exists, but rather the principle of the State party’s exceptional prerogative powers in relation to the contract. It should be emphasized, however, that such principle would not permit arbitrary executive modifications of contract. It would permit contractual modifications only when made in a lawful regular manner, by decree or legislative act normally and for the public good.” One writer stated that “(ihe principle of government freedom of action means nothing more than that the government has the inherent power to override its contractual obligations by unilateral action in so far as public interest demands so”.”° This writer agrees with this statement to the extent that it states the main power fundamental to the principle of governmental freedom of action, However, the phrase “means nothing more than” suggests that the power to effect unilateral changes to the licensce’s rights is merely trifling. The powers of the government are of much greater consequence. In effect, government freedom of action defeats the purpose of making the distinction between a contract and a regulation, The restriction on unilateral amendments is an essential character of modern contracts. One would expect that if a licence were indeed a contract, this would afford greater protection to the rights of the licensee, On the contrary, the state of the law appears to provide that the licence is contractual in form, arguably in character, yet the government can override its contractual obligations. What then, is the point 7 of giving it contractual status’ 3. THE REGULATORY FLAVOUR OF THE LIC! The licence is granted by the Secretary of State under powers conferred directly by section 3 of the 1998 Petroleum (Production) Act (as amended). In this respect it is merely a contract between the minister and the license .. The same Act in section 4 provides that the Petroleum (Production) Regulations con:ain model clauses, which are not binding regulations, but derive their legal force vis-a-vis the li from being incorporated into it.”* Arguably, it is the model clauses and not the licence itself that are regulatory in character. However, this is not of significant import, as the model clauses are applied to all licences.””As to the form of the licence, the standard clauses, which are to be incorporated into the licence, are strikingly similar to the way statutory powers are framed.”” In substance, modern licences (as opposed to those granted pre-1934) are agreements, which provide for substantial state participation in, and control over, the petroleum venture.’! The extensive powers of the minister provided in the model clauses, and the fact that they are laid down by regulations at the insistence of Parliament cleerly taints the licence with a regulatory flavour.” The licence confers on the licensee, the right te take any hydrocarbons found, and not much else in the nature of rights The obligations it imposes on the other hand are draconian, regulating such matters as working methods, pollution and training. ‘The popular consensus of writers on this topic is that the petroleum production licence is a contract between the minister and the licensee that has to it a regulatory flavour. It is submitted that the regulatory element of the licence is more than merely a “flavour”. On the contrary, it resonates to the very core of the relationship between the licensee and the government. Although it remains contractual in form, government action in terms of the unilateral alterations made to licence terms makes one doubt whether licences retained any contractual character at all." The statement of one eminent writer that the production licence is in summary, the “use by the government of contractual tzrms and procedures as an instrument of regulation of the behaviour of the subject” is more agreeable. ** 4, PRACTICAL SIGNIFICANCE OF THE DISTINCTION, Having discussed the dual nature of the licence, it raises the issue of what this means in the general context of the law, and in the day-to-day practice of the petroleum industry. One scholar opined that the significance of characterising the production licence into contractual or regulatory lies in the protection and juridical security afforded the rights of the licensee as a consequence of this division.” If the licence were in fact a contract, it would supposedly offer more protection to the rights of the licensee, Unfortunately, it is not quite as straightforward in practice. The reality of the situation is a continuous balancing act between the vast powers of parliament with the checks of the courts, and actual government practice.‘The Principle of Parliamentary Supremacy. Many oil producing countries have relied on the principle of the state’s sovereignty over its natural resources, as contained in a number of United Nations General Assembly Resolutions as a means of justifying their interfering with concessions and licences contrary to the UN provisions.’ The furtherance of parliamentary sovereignty by the UN is aptly reflected in the General Assembly Resolution No, 1803 XV11 of December 14, 1962, which states that: - “Nationalization, expropriation or requisitioning shall be based on grounds or reason of public utility, security or the national interest which are recognised as overriding purely individual or private interests, both domestic and foreign.... the state taking such measures in the exercise of its sovereignty and in accordance with international law.” Whether a licence is granted as a contract or a purely regulatory mechanism, in the light of the powers of parliament, is a subtle distinetion. The Crown may override obligations, whether contractual or statutory where it is in the public interest to do so. When rights are granted through statute, as are the licensce’s rights, they may not be withdrawn or amended unless in exercise of further statutory authority or with the consent of the grantee.** One learned writer is of the opinion that the courts would treat rights granted under statutes in the same way as if they were acquired under a government contract.” 4.2, Judicial Review. It has been established that its regulatory aspects, and the principle of parliamentary freedom of action largely undermine the contractual character of the produetion licence and the protection of licen: ” rights, However, the wide discretionary powers of the minister are tempered by the availability of judicial review and the requirement that the minister (or other public authority) acts withi powers for the welfare of the state. According to Lord Denning: - “These courts have the authority — and I would add the duty — in a proper case, when called upon to enquire into the exercising of a discretionary power by the minister or his department. If it is found that this power has been exercised improperly or mistakenly so as to infringe unjustly on the legitimate rights and interests of the subjects, then these courts must so declare. They stand, as ever, between the executive and the subject, ... alert to see that any discretionary power is not exceeded orThe courts’ powers of judicial review are limited in scope. They may provide recourse with regards to the interpretation of the licence and the exercise of the minister’s powers thereof, However, there is little the courts may do to prevent parliament enacting adverse legislation. The judgements delivered in cases such as Commissioners of Crown Lands v. Page and Re 56 Denton Road, Ts ckenham show that the courts have expressly acknowledged that legislation passed by parliament in the exercise of its executive powers is outside the ambit of the courts? authority.*! 4.3, Remedies. While the licensee may not rely on contract to prevent the application of general statutory ot other powers of the government, he may seek redress in the doctrine of “frustration” so as to escape fiom his obligations on more favourable terms than if he exercised his right to surrender.” English contract law provides that if a contract subsequent to its formation becomes legally or physically impossible to perform, or if events subsequently occur (without the fault of either party) with the result that to enforce the contract in the changed circumstances would amount to enforcing a different contract from the one the parties made, both parties will be released from further performance of their obligations by virtue of the doctrine of frustration.”* It is imperative to note that the doctrine does not apply to amending the contractual rights and obligations of the parties — the effect of frustration is to terminate the contract.* In the event that the government exercises its discretionary powers to supersede its contractual obligations, compensation may be awarded in contract for the premature termination or the added obligation imposed on the other party.** This equitable principle requiring payment of compensation is however not firmly established in UK law. No provisions were made for compensation when the Petroleum and Submarine Pipelines Act of 1975 made unilateral changes to existing licences. A number of authors have criticised this Act of parliament as having no respect for the United Kingdom contractual obligations."* Despite the controversy and disapproval stirred, the 1975 Act remains valid and the licences affected by it did not lose legal status. ‘This goes to buttress the point that contractual status does not necessarily provide greater protection to production licences.4,4, Government Practice, The supremacy of government cannot be overemphasised. It adds a regulatory dimension to the licence that almost surmounts the contractual character of the licence. That is not to say that there is no security for potential investors as licensees. To say so would be to disregard state practice in favour of doctrinal pronouncements. Much ado has been made a2out the unilateral amendments made by the government, most especially the 1975 Act. However, it has been submitted that the Act passed in 1975 was only “formally” unilateral, In practice, it followed discussions and negotiations between the department of energy, the treasury and existing licensees on an unprecedented scale in the history of British politics. These negotiations went on over a period of several years. The Act was iecompanied by many assurances to the licensees (and their banks) conceming the exercise of the new powers it contained, The government’s willingness to listen and consider their suggestions, and the assurances made by the government made it easier for the industry to accept the changes made”, Some have criticised these government assurances as being a token gesture to quieten protests of the licenses . Arguably, the government was careful not to incorporate the assurances into the legislation so as not to give them legal weight. There have been doubts expressed as to how long the government will actually stand by its word. In 1984 an eminent author predicted that although the government's pledges were backed by moral force, this would “diminish over time” and after there had been changes in government.** In 1994, another writer expressed this shared opinion, stating, “A future change of government might lead some to wish they had defended the principle [prohibiting unilatere! alterations of contractual terms] a little more vigorously”. Over two decades and a few changes in government later, the rights of the licensee are just as safe as they were when the assurances were originally made. 5. CONCLUSION. It is useful to try and label the petroleum production licence, but impossible to neatly compartmentalize it. Without doubt, the licence is contractual in form. Nonetheless, there is another side to the licence that is evidently regulatory. In answer to the question “What is the legal character of the production licence?” it is submitted that it is in fact a regulation masquerading as acontract. Whether the licence is tagged as a contract or regulation, the state still maintains maximum control and can exercise its executive powers to get around the limitations to unilateral amendments of the agreement. It is only by looking deeper beyond the labels such as ‘contract’ or ‘regulation’ that one may truly appreciate the nature of the licence. The presence of legal and political security whether real or psychological is a major incentive for investment.*” It has been suggested that determining the legal status of the licence will lead to added certainty as to the position of the licensee's rights. However, it is submitted that it is not the nature of the licence that protects the licensee, but the other limitations on the powers of parliament’! and actual government practice. The aim of the government is to ensure the possibility of carrying out petroleum development in a satisfactory manner while at the same time promoting national interest. The licence is not the aim itself, but a means of achieving it. This is what is to be focused ‘on, and not the vehicle by which it is attained. Even though the principle of parliamentary supremacy allows the government to more or le determine the fate of the licensees, this does not necessarily mean that it will act to their jiderable investments in the detriment, On one hand, oil companies will continue to make cor UK, despite the uncertainty of licences being altered by subsequent regulation, This is because the United Kingdom possesses substantial proven petroleum reserves and the remaining aspects of this country’s legal, social, economic and political system suggest that the companies ean count on a stable investment climate.” On the other hand, government needs the industry’s capital, technology and know-how almost as much as the industry needs the government’s oil deposits. The greatest security against arbitrary governmental action today is the genuine reciprocity of government’s relationship with the private oil industry.** ENDNOTES: ' p, Cameron, Petroleum Licensing, a Comparative Study, (1984). J. Jok, The Concession and the iJcence as Oil Production Titles, (unpublished Dip. Pet. Law dissertation submitted to CEPMLP, University of Dundee, 1982), at p. 3 * The Government benefits from ihe expertise and capital provided by the private companies, while the companies ‘gnin the right to explore and exploit the petroleum resources, The mutual benefits derived from the Government- LLicensce relationship will be discussed further below. * See T. Daintith and G, D. M. Willoughby, eds., A Manual of United Kingdom Oil and Gas Law(1977) pp. 221 and 231 “7. Daintith, G. Willoughby and A. Hill, eds., Daintth and Willoughby’s United Kingdom Oil and Gas Law, (2000) p. 1045 See P. Cameron, supra note 1 ” See T. Daintth, supra note 5, at p.1046*T. Daintith, The Petroleum Production Licence in the United Kingdom, in Daintith, T., ed., The Legal Character of (1981), page 216. See Petroleum (Production) (Seaward Areas) Regulations 1988, Schedule 4, clauses 2, and 9-12. * Now s. (4) of the Petroleum Act (1998). oD 1 Rederaeal laget Amphitrite v. The Crown [1921] 3 K.B. 500, supra note 8, at 9.215. " Ibi. ., where T. Daintith uses the analogies of a managerial contract for an aspiring pop star and government contracts for building work, “whose status as contacts has never been questioned” ''R, Pritchard, Before You Venture Forth - A Checklist of Legal safeguards for Foreign Investment in Energy and Natural Resources Projects. htp/fwww. dundee a.uk/cepmlpliouralml/atiled-14himl 5 Supra, note 1. ‘6 Thid., per Rowalt, J. at p. 503. 171960) Q.B. p. 274, '* This principle has also been accepied and applied in a number of other cases, See for example, tes v_ Oswald, (1883) 3 A.C 623; Boaad of Trade v, Temperley Steam Shipping Co, Lid. (1926) 26 L1.LR 76 and William Cory and Sons Ltd, V, City of London Corporation (1951) 2 K.B. 476. '° See the obiter of Denning, J. in Rcbertson v. Minister of Pensions, (1949) K.B. 227. ” Ibid, at 231. * Ibid. See further discussion, infra, at 5-6. The Petroleum and Submarine Pipelines Act 1975, Oil and Gas (Enterprise) Act 1982 and Petroleum Act 1987. See J. Armstrong, UK Petroleum Licensing An Iniodhtion, (unpublished) paper presented at the University of Dundee CEPMLP Summer Course 1994 * See T. Daintith, supra note 8, at 27. * D. W. Bowett, Claims Between States and Private Entities: The Twilight Zone of International Law, 35Catholic Univ. L. Rev. (summer 1986, No. 4), at p. 935. % See Jok, supra, note 2, at p.69. 27 The provision only applies however, where amendments are necessary inthe public interest. The practical effet of this is discussed below. * See T. Daintith, supra note 5, at 1064, ® Except in exceptional circumstances. Petroleum Act 1998, s. 4(1}(e). *'T, Daintith, Regulation by Coniract: The New Prerogative, in Current Legal Problems 32 (Lord Lloyd of Hampstead, and R. W. Rideout, eds., 1979). Per P, Cameron, supra note | TY, Daintith, supra note 24, Daintith maintains however, that “this does not displace the essentially contractual nature ofthe licence” ** A detailed list of the model clauses and the obligations imposed is not necessary for our purposes. Suffice to say that over half of the clauses confer powers on the minister, and obligations onthe licensee, See schedule 4 ofthe Petroleum (Production) Seaward Areas) Regulations 1988, Also, Armstrong, sipra note 23 a2 * Daintith, supra note 30. * Ibid. % See Jok, supra, note 2, at p. 39 "The relevant provisions most commonly relied on by oil producing countries include 1. “Declaration on the Establishment of the New International Order”, Resolution No. 3201 (S-VI) adopted on May 1, 1974. Article 4, para. (c). 2. “Charter of Economie Rights and D of the States", Resolution No, 3281 (XXIX) of July 26, 1974. Art2, See the cases of Livingston v Westminster Corporation [1904] 2 K.B. 109 and Re 56 Denton Road, Twiekenham, [1953] ch. 51. 2 F. Daintith supra note 8, pp. 222-223. Lord Denning, M.R., Restraining the Misuse of Power, The Jubilee Presidential Address to the Holdsworth Club of Faculty of Law, University of Bimmingham, 1978, “See discussions on government freedom of action above. See William Cory & Son Lid. V. London Corporation [1951] 2 K.B. 476. © See Taylor v, Caldwell (1863) 122 Eng. Rep. 309 K.B. “Soe British Movietonews v, London and Distriet Cinemas (1952) A.C, 166, * Attorney General v. De Keyser’s Royal Hotel (1920) A.C. 508. “TT, Daintth and G, Willoughby, A Manual of United Kingdom Oil and Gas Law 30 (1977), © See Cameron, supra, note 1 "© tbia © See J, Armstrong, supra note 2,at p3. See Jok, supra note 2, at p 51 51 These include consideration forthe public welfare, judicial review (discussed above) and the need to maintsin good relations withthe private companies, 5 See Moss, G.C. Contractor Licence? Regulation of Petroleum Investment in Russia and the Role of Foreign Legal Advice, heip:/Iwww dundee ac-uk/cepmalp/jouralimnlarticle3-L html Seo Moss, supra, note 30. °°, Daimith, supra, note 8 BIBLIOGRAPHY. BOOKS Bentham, R.W. and W.G.R. Smith, Precedents in Petroleum Law: Commentary and Texts, (2"! ed.) (Butterworths and Co., 1990), Cameron, P., Petroleum Licensing, a Comparative Study (London, England; Financial Times Business Information Ltd., 1984), Daintith, T. and G, D. M. Willoughby, eds., A Manual of United Kingdom Oil and Gas Law, (London: Sweet and Maxwell, 197). Daintith, T., Regulation by Contract: The New Prerogative, in Current Legal Problems 32 (Lord Lloyd of Hampstead, and R. W. Rideout, eds., London: Stevens and Sons, 1979). 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