The Principle of Reasonableness in Oil and Gas Contracts

Document Type : ISI

Authors

1 Associate Professor, Department of Energy and International Trade Law, Faculty of Law, University of Tehran (Farabi College), Tehran, Iran.

2 PhD Candidate in Oil and Gas Law, Faculty of Law, University of Tehran (Farabi College), Tehran, Iran.

Abstract

 Introduction
Oil and gas, and the contracts involving these commodities, are of strategic and vital importance worldwide. Meanwhile, contracts concluded for the purposes of exploration, development, and production are more complex than other petroleum-related contracts, including purchase and sale agreements. The former, known as upstream oil and gas contracts, exist in various forms, including concession arrangements, joint venture contracts, production sharing agreements, and service contracts such as buyback and IPC (Iran Petroleum Contract). Despite the differences between these types of contracts, they share several common features.
 First, these contracts face numerous uncertainties and are inherently risky, particularly the risk of failure in achieving exploration objectives, such as discovering commercially viable oil reserves, resulting in uncompensated losses and the inability to recover the capital invested. Second, the long duration of these contracts adds to the complexity of drafting them, as governing factors and conditions may change over time. Third, one of the parties is typically the host state or an institution representing it, which can become a determining factor in disrupting the contractual balance in favor of the reservoir-owning state.
 Contracts are governed by various principles that influence their drafting, execution, and interpretation. These principles are general and permanent, representing the legal values governing society, from which applied principles and rules originate. Many of these general principles also apply to oil and gas contracts. One such principle is the principle of reasonableness, also referred to as the principle of conventionality. The principle of reasonableness is a legal criterion that, by following the standards of rationality and established custom, aims to establish contractual justice and ensure the logical conformity of the real and objective terms and conditions of contracts with the subjective forms of law and reason. This principle operates from the initial stages of contract conclusion through its execution, termination, adjustment, or interpretation, and may also serve as a criterion in judicial adjudication or sanction.
Method
The present research, carried out through a descriptive–analytical method and based on library sources, aims to investigate the application of this principle in petroleum contracts. As noted above, while the principle of reasonableness governs contracts in general, petroleum contracts possess special characteristics that warrant deeper examination. Accordingly, this article seeks to answer whether, despite the specific features of petroleum contracts, the principle of reasonableness governs them. If the answer is affirmative, what examples demonstrate this principle in practice? The hypothesis of this research is that, in addition to the general applicability of the principle of reasonableness in oil and gas contracts, numerous examples of such applicability can be found in practice.
Conclusions
The findings of this research are divided into two parts. The first part, assuming the applicability of this principle in the aforementioned contracts, demonstrates how the principle of reasonableness provides protection for both contracting parties and balances the interests of the reservoir owner as a sovereign state and the investor as a private party. It further argues that oil contracts are state contracts rather than administrative contracts. Oil contracts do not derive their validity solely from the will of the government, and unilateral authority is not an inherent characteristic of these agreements that would exclude the application of the principle of reasonableness. The historical fluctuations in the processes of nationalization and the evolution of compensation methods further illustrate the feasibility of applying the principle of reasonableness in petroleum contracts.
The second part examines various manifestations of this principle by referencing clauses from production sharing, concession, and service contracts, showing that reasonableness appears most prominently in the fiscal regime of oil contracts. A clear example is the inclusion of renegotiation clauses, which reinforce party autonomy and enable contractual adjustment in line with reasonableness and contractual justice. The modern stabilization clause also reflects this principle, balancing investor rights with host state sovereignty. The use of sliding scales, mechanisms that automatically adjust the contract in response to predefined variables, illustrates another example of reasonableness aimed at maintaining contractual balance.
Furthermore, reliance on field realities exemplifies the application of the reasonableness principle. The oil field behaves as a dynamic entity and must be managed according to its evolving conditions; thus, contract terms should logically adapt to such realities. For example, enhanced oil recovery measures and the reasonable calculation of incurred costs align contract performance with field conditions. Similarly, avoiding rigid capital cost caps and ensuring adequate monitoring of annual work programs and budgets reflect reasonableness in practice. Finally, the breaking of ring-fencing and the growing trend toward the consolidation of fiscal regimes across multiple contracts with the same investor, along with the provision of fair conditions for investors facing financial loss, further demonstrate how the principle of reasonableness mitigates risks and strengthens the contractual framework in the petroleum industry.

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Main Subjects

References

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Journal Of Researches Energy Law Studies
Volume 10, Issue 2
March 2025
Pages 253-280

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