In modern-day international investment practice, especially in connection with the exploitation of natural resources, Production Sharing Agreements have come to take over the role of the classic concession agreement. Like their predecessors, these contracts are particularly vulnerable to disturbances in the commercial balance agreed to, or assumed by, the parties at the conclusion of the contract. This vulnerability has three primary causes.
First, these are classic examples of long term contracts. In the petroleum industry, the commitment of significant capital for exploration, particularly in development, and the assumption of considerable risk, particularly in exploration, require contracts covering up to and over ten years of exploration, and over twenty years of an initial production phase. The long duration of these contracts makes them particularly susceptible to political or economic influences which are unforeseeable at the time of contract conclusion, but which from the investor's point of view have a negative effect on the economic equilibrium of the contract.
Second, the investor will initially incur significant costs in setting the exploration strategy in motion (sunk costs), which will only be recovered over the duration of the contract. The investor therefore unavoidably depends on the contract actually being carried out for the length of time and on the basis of the framework initially negotiated with the host country.
Third, many host countries make use of the investor's "prisoner's dilemma," pressing for changes to the originally negotiated equilibrium in their favor once the venture has begun, i.e. once the investor has a large amount of sunk costs at stake. In particular, this is likely where exploration plans have proven to be more profitable than originally expected. These negative changes in the investment climate occur through amendments to the relevant laws, tax increases or a more or less forced renegotiation of the contract (obsolescing bargaining)...
This article will examine ways to protect the investor against these sorts of risks and uncertainties. Two scenarios need to be distinguished. In the first scenario discussed infra in Section II, the contract contains no specific adjustment or renegotiation clause. In the second scenario, discussed infra in Section III, the parties have included special provisions in their contract to deal with these cases.
Klaus P. Berger,
Renegotiation and Adaptation of International Investment Contracts,
36 Vanderbilt Law Review
Available at: https://scholarship.law.vanderbilt.edu/vjtl/vol36/iss4/9