Tying Their Hands? How Petroleum Contract Terms May Limit Governments’ Climate Policy Flexibility

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The pathway to net-zero emissions will be a fraught one for many petroleum-dependent countries. Radical policy action is necessary to decarbonize the global economy, with significant economic implications for countries dependent on oil and gas revenues. The Intergovernmental Panel on Climate Change has warned that global warming will exceed 1.5 and even 2 degrees Celsius without deep emissions cuts. At the same time, the International Energy Agency has proposed a freeze on new development approvals for oil and gas fields from 2021 if we are to limit the global temperature rise to 1.5 degrees Celsius.

Current and emerging producers may want to go beyond merely reacting to foreign governments’ or international oil companies’ evolving climate policies – they may seek to proactively decarbonize and build climate resilience in their own petroleum sectors. Yet the long-term contracts governments sign with companies for petroleum exploration and production may significantly limit this flexibility for decades.
 
Have producer countries begun to modify petroleum contract terms in response to climate change and energy transition risks?

To explore this, the author of this briefing reviewed 34 contracts and model contracts from 11 countries, signed or issued since the Paris Agreement. This review focused on stabilization, arbitration, and force majeure clauses.
 
The contracts reviewed do not yet indicate a shift in these clauses to respond to climate change risks, and the need for government flexibility to take climate policy action. Producer governments should reconsider traditional contract clauses and assess and adapt their petroleum sector legal framework to address energy transition and climate change risks.

Key messages:

• The transition away from fossil fuels toward renewable energy sources will have a significant impact on petroleum-producing countries, whose governments will need flexibility to adapt their petroleum sectors to new realities.
• A review of 34 publicly available contracts from 11 countries signed since the 2015 Paris Agreement demonstrates that petroleum contract language may limit governments’ policy flexibility and may not adequately address climate event risks.
• Traditional clauses like stabilization, arbitration and force majeure should be reconsidered to address climate change risks and the need for climate policy action.
• The Intergovernmental Panel on Climate Change has warned that global warming will exceed 1.5 and even 2 degrees Celsius without deep emissions cuts, while the International Energy Agency has proposed a stop to new development approvals for oil and gas fields as a pathway to net zero emissions. Continued petroleum development therefore comes with many risks for petroleum producers.
• Those governments that nevertheless choose to pursue new petroleum projects to fulfil national development goals should assess and adapt their petroleum sector contracts and legal framework to address energy transition and climate change risks.