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Global legal challenges facing the petro-chemical industry

Speech given by Peter Rees, Legal Director, Royal Dutch Shell plc, at the University Club of Toronto, on May 8, 2012.
Peter Rees

The petro-chemical industry has long faced many global challenges: technical, logistical, political, environmental and legal. In this speech, Shell Legal Director Peter Rees examines the scope of those challenges, and focuses on three major ones on his agenda today: Financial transparency, piracy, and contracting/procurement. In doing so, he demonstrates how the role of the corporate legal counsel has become central to resolving the major challenges facing global corporations today.

Global legal challenges facing the petro-chemical industry

Exactly 52 years ago today, in 1960, Time Magazine published a major cover story about Shell, its global operations and challenges. This is how it began:

“Along the steaming, mud-covered delta of Africa’s Niger River, bare-chested men labored amid crocodiles and screaming parrots this week to push shafts of steel deep into the earth.

“On the choppy waters of the Persian Gulf, others perched on a crablike platform and sent a snag-toothed bit boring into the ocean bed.

“Around the world, hundreds of men labored just as sweatily in 35 other countries – from the pampas of Argentina to the back hills of New Zealand – to probe the earth in an eager quest for the substance that makes the world’s wheels go round: oil.

“The men on the Niger, the men in New Zealand’s back hills are all employees of a single company, Royal Dutch Shell, the world’s second-biggest oil company, and by far the most international in scope, organization and spirit.”

All that talk of steam, sweat and bare chests in exotic locales is a bit reminiscent of a bad romance novel. But I digress.

The fact is today, many of the places we drill are even more challenging and remote. And these days, we willingly provide our workers with shirts. That aside, you could write virtually the same thing today, and you would still describe Shell accurately.

The petro-chemical industry has long faced global challenges – technical, logistical, political, environmental and legal. The challenges get greater with each passing year on all these fronts.

Tonight, I want to give you an inside view on the global legal challenges we face as the world’s second biggest energy company. Before I do, I’d like to offer a bit of context both in terms of Shell and our industry.

Last year, Shell celebrated 100 years of operations here in Canada. Most people know us through the fuels and engine oils we sell around the world. That’s not surprising when you consider Shell, with 43,000 stations, actually has more branded retail sites than McDonalds has restaurants.

If you look out of the window before your next flight takes off, you might well see a Shell truck pumping jet fuel into your plane – just one of the 7,000 aircraft we refuel at over 800 airports in 40 countries each day.

What may be less obvious are the ships we service in more than 600 ports around the world, or the 22 million tonnes of Shell chemicals that go into products we all use every day: detergents, packaging, carpets, computers and countless other items.

Shell directly employs around 90,000 people. But when you add the over 400,000 people working in Shell franchises and operations, and the half a million contractors on Shell sites, you are looking at nearly 1 million people working for or with Shell on any given day.

We spend about U.S. $1.1 billion annually on research and development, and our capital expenditure averages $30 billion a year.

So you can imagine that with that many people, that range of activities and that sort of spend, the legal issues we face are varied, challenging and often cutting-edge. Now, let me put those big numbers in a global context.

For all of Shell’s size and reach, we produce just 2% of the world’s oil and gas. So to account for all the oil and gas produced to meet the world’s energy demand each day, you have to multiply Shell’s scale by a factor of 50. That factors in the dozens of major public and private energy companies, hundreds of service and engineering companies, and thousands of logistics companies that comprise our industry.

It’s a very complex business. And the future is not going to get any simpler or easier.

Consider these facts:

  • In the coming years, hundreds of millions more people will emerge from energy poverty, buying their first washing machines, refrigerators, computers and cars.
  • By 2050, our children will share this planet with 9 billion people, up from 7 billion today.
  • That is like adding another China and another India to the world. We will be creating the equivalent of one new city with a million people every week.
  • The energy industry globally is going to have to spend trillions of dollars over the next four decades to find, develop and produce the energy needed to meet these people’s needs.
  • That energy will come from more challenging and expensive sources, including oil sands, shale gas, liquid-rich shales, as well as advanced biofuels, hydrogen, wind and solar.

But the challenges go beyond allocating capital and developing more sophisticated technologies. For while energy underpins the world’s well-being, producing it also puts enormous pressure on our environment and social fabric. Resolving the tensions between these competing needs means making difficult judgments: technical, financial, legal and moral judgments.

And in the way the world is moving, the legal judgments are becoming more and more entwined with the moral judgments. Hard law and soft law are getting more and more difficult to differentiate, and the industry is being held to account to both.

There’s a wide range of global legal challenges facing the petro-chemical industry today, including:

  • Extraterritoriality – nations that seek to impose their laws and jurisdictions outside traditional geographic and jurisdictional boundaries.
  • There’s increased regulation in almost every aspect of our operations, from deep-water drilling to oil trading, from what we can and can’t say to our shareholders to how we pay our executives.
  • There’s the interaction of the laws of states, the obligation to do something in one nation that is illegal in another.
  • There’s the impact of politically motivated actions on the rule of law and sanctity of contract, resulting in actions such as expropriations or retrospective laws.
  • There’s the increasingly uncertain business environment caused by the breakdown in trust between governments, corporations and civil society.

And those just scratch the surface. There is a reason why we have more than 700 lawyers at Shell, working in more than 40 countries.

In the interests of time, I want to cover just three of the major issues on my plate at the moment. I categorise them as follows:

  • The one that looked insoluble, but which turned out not to be.
  • The one that looks insoluble and continues to be.
  • And the one that looks perfectly soluble, but which legislators are making insoluble.

Financial transparency

I’ll start with the last one, which is about the issue of financial transparency.

The English barrister, F.E. Smith, who became Lord Chancellor of England and Winston Churchill’s closest friend, was known for his incisive wit and precision of expression. In one case, he was making lengthy submissions to a judge who was clearly struggling with the complexities of the dispute.

The judge interrupted him and said: “Mr. Smith, I have listened to you now for an hour and I am afraid I am none the wiser.” To which Smith responded: “No wiser, my Lord, but much better informed.”

Keep that response in mind, because it is relevant to this topic.

There is a move afoot to require companies from the natural resource industries to disclose the amount of money they pay to governments for the right to extract their natural resources. It began in the United States and has now spread to Europe.

Why? So the people in those countries can see how much money their government is receiving for those public resources. The thinking is they can then hold their governments accountable for what is received. Some even argue it would reduce corruption.

It all sounds laudable when put in this way. But as with most legal issues, the devil is in the detail. In fact, what is being proposed won’t achieve any of those aims. Let’s take a closer look at each claim.

First, people will not find out how much their government is receiving. That’s because the only corporations this legislation can apply to are those under U.S. or European jurisdiction. The biggest energy companies in the world, the national oil companies and quasi-nationals from Russia, China, Asia-Pacific, South America and the Middle East, don’t fall under U.S. or European jurisdiction.

So, the total amount many governments receive will not be revealed by this legislation.

Will it reduce corruption? No. The legislation only requires a company to disclose how much it paid to the government. It is not corruption to pay a government taxes, royalties and signature bonuses for the rights to extract oil and gas; that’s what governments do – they sell their mineral rights to the highest bidder.

But this legislation does pose competitive harm to the companies required to comply with it.

Let’s say you are from a country not subject to this legislation. You and the government official negotiating the contract both know what the competition is likely to bid, because they have had to disclose what they bid for previous, similar contracts. Meanwhile, what you pay will never have to be revealed. And neither you, nor the government official, is caught by the US or European anti-corruption legislation.

I leave you to draw your own conclusions about the implications.

In case there should be any doubt, let me be clear: Shell supports financial transparency reporting. Two weeks ago, Shell published the total amounts we paid to governments last year in most of the main countries in which we operate. We did this in advance of any mandate to demonstrate our commitment to disclosure. We believe it is important that companies be open regarding how much they pay to governments.

We also believe governments should be encouraged to be open about what they receive and how they spend it.
People should know what their governments receive for rights to extract natural resources. But they should get the full picture, and the only entity in the position to provide the full picture is the government.

There are a few governments that do just that. Nigeria and Norway, for example, comply with EITI, the Extractive Industries Transparency Initiative. EITI encourages governments to disclose and verify all amounts they receive from all entities that extract their natural resources. This way, people get the full picture and not a distorted or partial one.

As F.E. Smith might have said to a smarter judge, they are both better informed and wiser.

Shell is a founder and board member of EITI and firmly believes its approach is the most effective way to provide revenue transparency. But that does not seem to be direction in which legislators are heading. Instead, governments generally seem to be favoring legislation that would force US and European companies to disclose what they are paying for individual projects – so all the downside and none of the benefit.

But what happens when that mandate conflicts with what other governments require? Some governments require you to enter into confidentiality agreements barring you from disclosing what you are paying them. Some even make it a criminal offence to do so. So to comply with the legislation in one country to disclose this information, we would have to violate the law of another country.

What should we do?

The Dodd-Frank legislation in the United States says it does not matter that to disclose the information would be illegal in another country, you still must disclose. And therein is my dilemma: Do I advise my company to be illegal in the United States or illegal in another country?

Again, an issue that looked perfectly soluble, but which the legislators are making insoluble.

Now, let me turn to the one that looks insoluble and continues to be: Piracy.

Piracy

Back in the 18th century, it was considered perfectly legal for a ship’s crew to hang pirates if there was no legal process available, as in international waters. This was considered a necessity, since captured pirates were considered too dangerous to keep on board during lengthy voyages at sea.

While the administration of the ultimate penalty seems severe today, it largely eliminated piracy by the late 19th century. Of course, we don’t hang pirates today – and I hasten to add I am not advocating that we resume the practice! But the fact is no one really has a clue what to do with today’s pirates.

There is no international body empowered to try and imprison them. Nobody wants to hold pirates on a ship until they return to port, because they can only be tried if the vessel subject to the pirate attack was under the flag of your nation. Not surprisingly, trying pirates is not the sort of business flag countries like Panama, Bermuda and the Marshall Islands are eager to embrace.

Jurisdiction is the issue. Piracy, by definition, happens on the high seas, outside anyone’s jurisdiction. And if you can’t hang them, you can’t imprison them and you can’t take them back to shore, what do you do?

This is not just a practical problem, but a legal one as well, for my industry and others that must ship products through seas where pirates operate. We and other oil companies have little choice but to ship our products either through the Suez Canal, down the Red Sea and out into the Indian Ocean, or down the west coast of Africa.

In the past two years, there were about 15 pirate attacks a month on vessels in the Indian Ocean, of which about 20% were successful. Attacks off the coast of West Africa ran averaged about seven a month.

So what can we do to resolve the problem?

Initially, vessels used defensive tactics such as higher seaboards, putting razor wire round the ship or employing water cannons. But when some vessels began carrying armed soldiers or guards, a different set of legal questions came into play:

  • What legal considerations apply to arming vessels?
  • What is the attitude of the nations under whose flags these vessels operate?
  • What liabilities will they incur if a death occurs during a pirate attack?
  • What is the attitude of the vessels’ insurers? Will they deny insurance claims?
  • What will the attitude be of the armed guards’ countries if they are killed or if they kill or injure someone?
  • And what if that someone isn’t a pirate, but an innocent bystander, such as a fisherman or a crew member caught in the cross-fire?
  • To what extent can consent from the flag country and insurers give you some protection?
  • To what extent can drawing up detailed rules of engagement for armed guards provide safeguards if there are subsequent injuries or deaths?
  • Where can criminal charges be brought? Which countries will have jurisdiction over civil claims?

I have just asked nearly a dozen legal questions, to which there are no definitive answers. What advice would you give when the question arises: others are arming their ships, what should we do? How do we fulfill any duty of care we may have to the crews of our vessels?  Are we in breach of our duty if we don’t arm? Or do we put our crews in more danger if we do?

These are no longer hypothetical questions. For example, two Indian fishermen were killed by Italian navy personnel on duty on an Italian flagged oil tanker as the vessel was sailing along the Indian coast. It appears they mistook them for pirates. India arrested the two Italian sailors. Italy accused India of breaching its territorial jurisdiction by arresting them in international waters.

Last month, Italy announced it had paid $380,000 to the families of two fishermen as a gesture of goodwill, but not as an admission of responsibility for the deaths. In response, the relatives agreed to withdraw their cases against the sailors. But the Indian state has not dropped its criminal charges against the two men and they are awaiting prosecution.

In February, Danish naval forces opened fire on a suspected pirate ship when it refused to stop. Two hostages being held by the pirates were killed. While it appears the pirates killed the hostages, the question arises: Would they have been killed if the navy had not attacked?

So, as with financial transparency, I leave you with a dilemma: Do I advise my company to arm our vessels or not arm them? And what do I advise will be the legal consequences if we do or don’t?

Okay, so far I sound like a guy with a lot of problems and no solutions. So I’ll conclude with an example of a major issue for which, I am proud to say, we have created a solution.

Contracting and procurement

Shell signs about 1 million contracts a year with more than 120,000 suppliers in practically every country in the world, generating an annual spend of $65 billion.

In the past, these contracts involved more than 100,000 different sets of contractual Terms & Conditions, or T&Cs, in more than 100 different legal jurisdictions. It was not the most efficient way to contract and purchase. Contracts were taking far longer than they should to negotiate, taking up unnecessary amounts of management and legal time.

This resulted in very different terms and conditions, and usually different prices, for the supply of fundamentally the same product in different parts of the world. This is a legal problem not just for Shell, but for nearly every multinational company in the world.

The solution is easy in theory: standardisation. But given the scope of our operations, is standardisation even possible in practice?

Well, since January 2010, the in-house legal team supporting Shell’s procurement function standardised the legal terms and conditions for all of Shell’s procurement contracts. We now have one standard set of T&Cs used by all of Shell’s businesses and functions.

How was it done? The core team consulted Shell lawyers, representing more than 100 countries, and the global network of Shell procurement professionals to develop a single starting point for the T&Cs. The goal was to make all the terms of the T&Cs enforceable in all jurisdictions.

They had to meet local legal and fiscal requirements as well as reflect the different needs of the businesses and functions that would use them. The T&Cs also would be used by our project contractors and joint ventures.

We adopted a fair starting point for the T&Cs to save time by eliminating the usual negotiating posturing. Our T&Cs are “fair market” and not skewed towards us.

In the beginning, some feared starting negotiations “from the middle.” They worried it would result in a worse outcome for Shell overall if suppliers still applied the traditional negotiating approach of starting at two ends of the spectrum and landing somewhere in the middle.

That has not proved the case, fortunately, because of the second change we implemented. Having a “fair” set of T&Cs has meant we can now adopt a different approach to negotiations. We simply attach the T&Cs to the tender invitation, and tell suppliers any mark-up of the T&Cs will be rejected.

Instead, they are invited to rank a limited number of reservations on the T&Cs as part of their tender response. We can only make this approach work because the T&Cs reflect a fair allocation of risk.

Shell’s standard model contracts library was rolled out in January 2011. Tracking data show the standard T&Cs are being used by more than 1,000 procurement professionals in Shell each month.

All sorts of advantages have resulted. Our contracting today is faster and more certain. On average, we’ve cut in half the time it takes to negotiate contracts. And there has been a significant improvement in the prices we are paying.

The project was devised, managed and implemented exclusively by Shell’s lawyers. Doing it in-house made sense, given the volume and complexity of the commercial legal work we deal with every day. We know of no company that has implemented this scale of change to its legal contracting techniques in procurement, with or without external legal support.

An effort like this that brings the business enormous value can only help increase the appreciation of what lawyers do within a company. Today, we are no longer viewed as getting in the way of business, as people who say you can’t do this or that, or that you can only do it this way.

That attitude has disappeared within Shell. It wasn’t always that way, however.

I’d like to close tonight by reading excerpts from a letter that Shell’s then-CEO Sir Henri Deterding sent in 1916 to the managing director of Shell’s operations in the United States:

Dear Mr. Luyks:

I duly received yours of the 22nd regarding Messrs. Rice & Lyons’ remuneration.

You gave me rather a start with your letter, because I gather from it that you employ solicitors much oftener than we would ever dream of doing.

Although we have an enormous business here, we rarely consult lawyers. We only do so when there is really a legal difference or legal difficulty, whilst it seems to me that you employ them practically in every instance.

Lawyers are not business people; however large a lawyer’s experience may be, in the conduct of business he is absolutely useless. A lawyer placed at the head of a concern would soon bring the business to rack and ruin.

He is not a creative genius, he is able to give his opinion if a case is laid before him, but to ask a lawyer to draw up a contract for you is a most foolish thing to do, and this is bound to lead to trouble.

Our custom here is to draw up a contract before having seen the lawyer and then to ask him to put it in more legal shape. Such a contract is more likely to embody the spirit of what has been agreed upon than one drawn up by a lawyer; to ask his opinion as to what you should do or not do is the worst possible way of conducting business, which should be kept as far as possible from lawyers.

It seems to me from your letter as if the lawyers are a kind of department to your business. Their idea that we should be inclined to give them a fixed fee is absurd, but what astonishes me most is their firm proposal that you should make an arrangement, by which one member of their firm should give practically his entire time to the conduct of our affairs.

We would never think of such an arrangement. I hate to see a lawyer in our office; if I want him I go to his office and limit the conversation to the shortest possible period.

Allowing a lawyer to be practically in daily touch with me would certainly take 90% of my time, which ought to be devoted to money-making and not to discussing legal squabbles or legal phraseologies.

Yours sincerely,
H. Deterding


There are many global legal challenges facing the petro-chemical industry today, some soluble and many which look like they won’t be. But what does seem to be accepted today is that we will need lawyers to help solve them.

Thank you.