Natural Gas Price Reviews: Past, Present and Future
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Natural Gas Price Reviews:
Past, Present and Future
Ben Holland and Phillip Spencer Ashley*
The last few years have seen a glut of natural gas price review arbitrations.
This article considers why parties include price review provisions in their long-
term gas sales agreements, how they should be interpreted and whether these
disputes will continue to occur into the future.
The past
Long-term agreements
The production and transport of natural gas are capital-intensive industries.
The exploration of reserves, the construction of pipelines and/or liquefaction
facilities and the purchase of liquefied natural gas (LNG) tankers are all
multi-billion dollar investments. Producers and liquefaction companies are
traditionally unwilling to make such capital investments without the assurance
of long-term commitments from potential purchasers.
These commitments are typically for 15–20 years and contain take-or-pay
obligations that require the buyer to take delivery of a minimum quantity
or pay for it in any event.1 These take-or-pay obligations guarantee the seller
that it will achieve a minimum volume of sales in each contract period, which
stabilises the resulting revenue stream.
The increasing reliance on loan financing by producers and liquefaction
companies has resulted in this type of long-term take-or-pay agreement becoming
an essential precondition for many projects, as the lenders require assignment
of the cash flow under the long-term agreements as security for the financing.
* Ben Holland is a Partner and Phillip Ashley a Senior Associate in the London office of
CMS Cameron McKenna specialising in energy disputes. The authors can be contacted by
e-mail at, respectively, ben.holland@cms-cmck.com and phillip.ashley@cms-cmck.com. The
authors would like to thank Rafique Khan (CMS Cameron McKenna) for his assistance.
1 European Commission, DG Competition Report on Energy Sector Inquiry, 10 January 2007,
47 to 55.30 Journal of Energy & Natural Resources Law Vol 30 No 1 2012
The price
In long-term commodity sales agreements, a fixed price for 15–20 years
is usually unrealistic, owing to shifts in the relative competitiveness of the
agreed price over time. This is equally true with long-term sales of natural
gas. In natural gas agreements, the contract price for each delivery is arrived
at through a price formula. The agreement of a price formula is no different
to any other negotiated compromise. A buyer and seller usually have entirely
different interests. For example, the seller might need to satisfy lenders
that a price formula will produce a minimum net present value to cover
the repayment of financing. This is likely to be a matter of indifference to
the buyer. The buyer will have entirely different concerns, relating to its
own customers and portfolio of contracts. The agreed price formula is a
compromise, much the same as any other transaction.
Most natural gas markets were historically national in geography. The
buyers in these national markets were publicly owned (or privatised)
monopsonists charged with responsibility for expanding importation,
distribution and consumption of natural gas. As monopsonists, in the
early years, they had no competition from other natural gas suppliers. As a
consequence, natural gas purchased by the buyer would be competing in a
nascent natural gas market with alternative fuels and not other natural gas.
There was no natural gas liquid ‘market price’ in these markets against which
to index price formulae. For this reason, most historic price formulae were
usually indexed directly or indirectly to alternative competing fuels, such as
oil products (for want of a better proxy).2
2 Ibid, 101 to 110. It should not be assumed that price formulae that are linked to oil
products pass through 100 per cent of any increase/decrease in oil product prices into the
natural gas contract price. The extent of the pass-through can vary significantly between
contracts and portfolios. For example, in 2004 Iberdrola explained to investors that it had
entered into additional natural gas sale and purchase agreements that have the impact of
reducing the pass-through of oil prices to its natural gas price purchase portfolio from 50
per cent to 30 per cent, meaning that a US$1/one million British thermal units (MMBtu)
increase in oil prices would result in a US$0.30/MMBtu increase in its weighted average
natural gas contract purchase prices (see Iberdrola presentation, Resultados Nueve Meses
2004, dated 22 October 2004, slide 38). In addition, indexation can contain price floors,
caps and collars to provide protection from substantial price realignments. As Louis Chiam
and Vishal Ahuja have observed, ‘Sellers will often insist on a price floor to give project
financiers satisfaction that there will always be sufficient cash flow to meet obligations.
Buyers will often want caps to reflect fixed pricing agreed in downstream contracts’ (see L
Chiam and V Ahuja, ‘Long-Term Supply Contracts – Time For Review’ (2006) 25 ARELJ
149). In relation to the negotiation of competing fuels’ pass-through factors generally
see: Energy Sector Management Assistance Programme, Long-Term Gas Contracts: Principles and
Applications, Report No 152/93, paragraphs 6.106 to 6.142.N atural Gas Price Reviews: Past, Present and Future 31
The problem
Agreeing a price formula that remains unaltered for the entirety of a 15–20-
year contractual term, regardless of future events, may reflect a risk that is
unacceptable to both of the parties. In addition to changes in the relative
competitiveness of the agreed price over time, structural market changes
can have an important impact on the original bargain. Structural market
changes can occur at the same time or independently of periodic changes
in relative competitiveness of the contract price. Perhaps the best-known
examples of the risks arising from such changes were the massive gas market
realignments in the United States (1980s) and the United Kingdom (1990s).
In the 1990s, British Gas found itself in a perfect storm. It had inherited a
large number of historic long-term contracts, agreed before its privatisation,
which required it to purchase North Sea natural gas at high prices that were
no longer realistic. A number of factors had caused the natural gas market
price in the United Kingdom to collapse to well below the prices that British
Gas was paying: the speed of liberalisation; the build-up of a gas surplus; and
delays to the construction of new gas-fired power stations.3 The vast majority
of these historic contracts did not contain price review provisions. In simple
terms, in a very different market where contractual quantities could exceed
demand and market share was being squeezed by new participating parties,
there was no contractual mechanism to amend the price.
British Gas turned to the UK Government and its sellers for a settlement.
The UK Government refused to intervene on a formal level, but made public
its desire that the parties should reach a sensible commercial renegotiation.
The sellers were aligned to reaching settlements only in as much as the natural
gas released by the negotiations might be sold to third parties or sold onto the
market by the sellers themselves. As a consequence, the settlements reached
by British Gas resulted in additional competition from natural gas released
by British Gas being sold by third parties or the sellers in competition with
British Gas’s natural gas. From a legal point of view, the lack of contractual
mechanisms in many of the contracts for resolving the price problem was
unsatisfactory and could only be resolved by the willingness of the parties
to renegotiate their agreements.
In particular, it had only been a decade since the large-scale renegotiation
of LNG sales agreements in the United States, which was caused by low prices,
reduction in demand and liberalisation of the US natural gas industry. For
3 See also Thomas Wälde and Abba Kolo, ‘Renegotiation and Contract Adaptation in
International Investment Projects: Applicable Legal Principles & Industry Practices’ (2000)
1 The Journal of World Investment 5. The authors of this article also point to ‘mild weather
which reduced demand’ as a factor contributing to the crisis in the United Kingdom.
However, this supposed factor is a matter of debate among gas industry experts.32 Journal of Energy & Natural Resources Law Vol 30 No 1 2012
example, Sonatrach and Distrigas fought a high-profile dispute relating to
the price of imports of LNG into the United States under a contract agreed
in 1976. The dispute continued through much of the 1980s and was only
resolved in 1988 when the parties agreed a new mechanism to share the
buyer’s revenue (one-third to the buyer and two-thirds to Sonatrach).4
It was apparent to all market participants that medium-term events could
have a catastrophic consequence on the contractual relationship between a
long-term buyer and seller.
The solution – price review provisions
The contractual mechanism adopted by the energy industry to deal with such
issues – and/or other events of the parties’ designation – is the price review
provision. These provisions existed in some contracts prior to the 1990s,
such as in Sonatrach’s contract with Distrigas. But after the experience of
the United Kingdom they were inserted in most long-term natural gas sales
agreements. Price review provisions provide the flexibility in long-term gas
sales agreements to deal with the risks associated with changing markets.
Although the industry is now largely agreed on the need for price review
provisions, it would be a mistake to assume that these price review provisions
are in a standard form. In reality, the term ‘price review’ (or ‘re-opener’) is a
term of art that is used to refer to a variety of different clauses that allow the
existing price formula to be adapted or replaced in specified circumstances.
The scope and effect of different provisions can vary enormously. However,
the provisions generally allow a reference to arbitration either expressly in
the words of the provision or by the inclusion of an arbitration agreement
in the contract.
Examples of differing price review provisions are:
Example 1 – Atlantic LNG Company of Trinidad and Tobago and Gas
Natural LNG SPA, 1995
‘(a) If at any time either Party considers that economic circumstances
in Spain beyond the control of the Parties, while exercising due
diligence, have substantially changed as compared to what it
reasonably expected when entering into this Contract or, after
the first Contract Price revision under this Article 8.5, at the
time of the latest Contract Price revision under this Article
8.5, and the Contract Price resulting from application of the
4 Extensive materials relating to this renegotiation are available on the US Department
of Energy website (www.fossil.energy.gov), including the original long-term sale and
purchase agreement and the amendment resulting from the renegotiation.N atural Gas Price Reviews: Past, Present and Future 33
formula set forth in Article 8.1 does not reflect the value of
Natural Gas in the Buyer’s end user market, then such Party
may, by notifying the other Party in writing and giving with such
notice information supporting its belief, request that the Parties
should forthwith enter into negotiations to determine whether
or not such changed circumstances exist and justify a revision of
the Contract Price provisions and, if so, to seek agreement on
a fair and equitable revision of the above-mentioned Contract
Price provisions in accordance with the remaining provisions
of this Article 8.5.
(b) In reviewing the Contract Price in accordance with a request
pursuant to sub-Article 8.5(a) above the Parties shall take into
account levels and trends in price of supplies of LNG and Natural
Gas [redacted] such supplies being sold under commercial
contracts currently in force on arm’s length terms, and having due
regard to all characteristics of such supplies (including, but not
limited to quality, quantity, interruptability, flexibility of deliveries
and term of supply).
(c) The Contract Price as revised in accordance with this Article, shall in
any event, allow the Buyer to market the LNG supplied hereunder in
competition with all competing sources or forms of energy… . And
such Contract Price shall allow the Buyer to achieve a reasonable
rate of return on the LNG delivered hereunder.’5
Example 2 – Sonatrach and Distrigas Corporation LNG SPA, 1976
‘The parties agree to meet regularly to proceed with the revision of the
Contractual Sales Price defined in Article 9 above. They shall so meet
for the first time during the first quarter of the year 1980 and thereafter
every four (4) years.
The revision of the price shall consist in adapting it in a reasonable
and fair manner to the economic circumstances then prevailing on the
imported Natural Gas market and on the market for the other imported
energy supplies competing with this production in the East Coast and
Gulf Coast areas of the United States of America within the framework
of long term contracts. The parties shall take into account the individual
characteristics of each of the above products including the quality, the
continuity of deliveries, the production and transportation costs, etc… .’6
5 2008 WL 4344525 (SDNY). Additional documents are available from the New York
courts, including a redacted version of the arbitrators’ award.
6 Available from the US Department of Energy at www.fossil.energy.gov. Distrigas
Corporation Docket No 88-37-LNG, Exhibit E-1: Agreement for the Sale and Purchase
of Liquified Natural Gas of 13 April 1996.34 Journal of Energy & Natural Resources Law Vol 30 No 1 2012
Example 3 – Clause Suggested as a ‘Typical Price Review Clause’
‘If a circumstance beyond the control of either party results in a significant
change in the energy market of the Buyer compared to such energy market
on [date], then either party may give notice for a price review.
If the parties fail to agree a revised price formula within 90 days after giving
notice for a price review, the price formula shall be reviewed by arbitration.
In any such arbitration the arbitrators shall review the price formula and
shall decide whether it needs to be revised to reflect, as at the review date,
the relevant significant change(s) in the energy market of the Buyer which
affect the value of [the product] in the end user market of the Buyer as such
value can directly or indirectly be obtained by a prudent and efficient buyer.
Any revised price formula determined by the arbitrators shall enable
the Buyer to market economically [the product] delivered under this
Agreement in the energy market of the Buyer in competition with other
competing sources of energy in the end user market of the Buyer, assuming
always the Buyer acts as a prudent and efficient energy company.’7
Although the Sonatrach contract is a 1970s agreement, experienced natural
gas practitioners will be aware of operative contracts containing similar words.
In addition, energy practitioners will be familiar with the type of hardship
provision considered in the English Court of Appeal case of Superior Overseas
Development Corporation and Phillips Petroleum (UK) Co Ltd v British Gas
Corporation.8 These provisions are drafted in a similar fashion to price review
provisions, but only operate if the change in economic circumstances has
caused hardship to one of the parties.9
7 Matthew Vinall, ‘If You Start to Feel the Pinch, Will a Price Review Clause Ease Your
Suffering?’ (2009) 1 IELR 17–19.
8 [1982] Lloyd’s Rep 262.
9 Clause 7 in the sale and purchase agreement stated:
‘(a) If at any time or from time to time during the contract period there has been any
substantial change in the economic circumstances relating to this Agreement and
(notwithstanding the effect of the other relieving or adjusting provisions of this
Agreement) either party feels that such change is causing it to suffer substantial economic
hardship then the parties shall (at the request of either of them) meet together to
consider what (if any) adjustment in the prices then in force under this Agreement or in
the price revision mechanism contained in Clauses 4, 5 and 6 of this Article are justified in
the circumstances in fairness to the parties to offset or alleviate the said hardship caused
by such change.
(b) If the parties shall not within ninety (90) days after any such request have reached
agreement on the adjustments (if any) in the said prices or price revision mechanism
which are to be made then the matter may forthwith be referred by either party for
determination by experts to be appointed in the manner set out in Article xviii hereof save
that the appointment of the third expert referred to in Clause 1(c) of that Article shall in
any event be made by the Minister of Power in consultation with the Lord Chancellor.
(c) The experts shall determine what (if any) adjustments in the said prices or in the said
price revision mechanism shall be made for the purposes aforesaid and any revised prices
or any change in the price revision mechanism so determined by such experts shall take
effect six (6) months after the date on which the request for the review was first made.’N atural Gas Price Reviews: Past, Present and Future 35 The present The current market To use Yogi Berra’s10 often-repeated phrase, experienced natural gas lawyers must feel like it is ‘déjà vu all over again’. After the perfect storms of the 1980s (United States) and 1990s (United Kingdom), the international gas markets are currently in the eye of another perfect storm. But what has caused the storm and how are the price review provisions drafted in the 1980s, 1990s and 2000s dealing with it? According to a report by Anthony Melling for the Carnegie Endowment for International Peace, this perfect storm is caused by a variety of factors: growing liberalisation, liquidity and transparency in Europe; too much contracted/committed supply; uncertainty about demand, particularly in power generation; and second-tier players as emboldened insurgents.11 These factors have all contributed to a downward pressure on natural gas prices. At the same time there has been an increase in price in the market for oil and oil products. As the majority of historic long-term natural gas agreements are indexed to the oil price or the price of oil products, price formulae in most historic long-term contracts have resulted in substantially increased contract prices. A number of market commentators have speculated that the divergence of dynamics fundamental to gas and oil prices over the last few years is the beginning of a permanent decoupling of the two commodities.12 In response, buyers and sellers have sought to operate price review provisions. For example, according to GasNaturalFenosa it has reopened 60 per cent of its natural gas purchase contracts for renegotiation (2010).13 Anecdotal evidence would suggest that GasNaturalFenosa is by no means unusual. However, if public sources are to be believed, the results of renegotiations across the industry have been mixed. Some renegotiations appear to have achieved notable successes. According to public sources, Gazprom has used a variety of mechanisms 10 Lawrence Peter ‘Yogi’ Berra, the former American Major League baseball player and manager, was famous not only for his catching skills, but also his tendency towards malapropism. Other famous examples include the oft-repeated quote ‘It ain’t over till it’s over’. 11 Anthony J Melling, Natural Gas Pricing and its Future: Europe as the Battleground (2010). Available at www.carnegieendowment.org. 12 For example, see Jonathan Stern, Continental European Long-term Gas Contracts: Is a Transition Away From Oil Product-linked Pricing Inevitable and Imminent? September 2009, Oxford Institute for Energy Studies. See also Jonathan Stern’s presentation Developments in the International Gas Markets and Prices delivered to the 3rd IEL-SEERIL International Oil and Gas Law Conference on 26 June 2011 in London. 13 GasNaturalFenosa, Strategic Plan presentation delivered to investors on 27 July 2010, 45. Available at www.gasnatural.com.
36 Journal of Energy & Natural Resources Law Vol 30 No 1 2012 to relieve pressure on its natural gas pipeline buyers. It has reduced some take-or-pay commitments from 90–85 per cent of ACQ (Annual Contracted Quantity) to 75–60 per cent of ACQ (E.ON and Botas). It has also agreed to add an element of spot pricing for purchases in excess of the take-or-pay commitment, based on a basket of European hubs (E.ON and GdF).14 However, it is much more difficult for LNG sellers to offer compromises through significantly enhanced volume flexibility (lower take-or-pay commitments as a percentage of ACQ). An LNG seller must be able to anticipate its exact sales so as to coordinate liquefaction volumes and shipping schedules. It cannot therefore offer the type of swing available (or offered) in the renegotiation of pipeline sale and purchase agreements. This places a greater emphasis on achieving a resolution through price review. While 65 per cent of the delegates at the 24th European Autumn Gas Conference, held in Bilbao during November 2009, considered that the issues to be decided are too profound and complex to leave to arbitral tribunals, the reality is a glut of price review arbitrations.15 The task Price review provisions can vary substantially. Experienced natural gas lawyers will understand that the reasons for the variations are numerous, including (to name a few): different cultural predispositions to contractual revision; the evolution of drafting preferences over time; differing practice among industry participants and markets; differing perceptions of risk; and factors relating to individual negotiations. A more detailed examination of these reasons would be the subject of a more substantial article, which is not possible here and might be of limited relevance in any event. Ultimately, the arbitrator’s task will depend on what the contract before the arbitral tribunal requires them to do, which can primarily be ascertained from: • the words of the price review provision; • the existing (or original) price formula; • the governing law of the interpretation of contract; • the arbitration provision; and • the relationship between the price review provision, the price formula and the rest of the agreement. 14 Dr Andrey A Konoplyanik, Gas Pricing Trends in Europe and its Consequences for Russian- Ukraine Gas Trade (Spot vs Long-term Indexation-based Pricing) presented at the World Independent Energy Network Round Table, Energy Issues in Europe and Russia-Ukraine Cooperation, 6 December 2010, Kiev, Ukraine. Available at www.konoplyanik.ru/ speeches/220.pdf. See also BP Statistical Review of World Energy: What’s Inside? (2010), 8. 15 Gas Strategies Group, Europe’s Gas Industry Needs Transformation to Adapt to Energy Revolution: Key Messages from the 24th European Autumn Gas Conference, held at Bilbao in northern Spain in November 2009, dated December 2009.
N atural Gas Price Reviews: Past, Present and Future 37
Price review provision
While some commentators refer to a ‘typical price review clause’, it is
important for an arbitral tribunal to focus on the words agreed between the
parties. Price review provisions are not standard form and arbitral tribunals
should be careful of accepting arguments that entirely different provisions
are intended to achieve the same purpose.
An arbitral tribunal should pay particular attention to:
• any requirement for a trigger event; and
• the scope of the tribunal’s mandate to revise.
Trigger
A price review provision will usually – but not always – require condition(s) to
be satisfied before a review can take place. These condition(s) are sometimes
referred to as trigger events.
It is open to the parties to agree that the passage of time will automatically
trigger a price review. This makes for a very simple trigger mechanism. For
example, the trigger event in the Sonatrach contract, referred to above, is
the passage of four years since the last price review. In these circumstances,
it is likely that the arbitral tribunal will have a simple task deciding whether
the trigger is satisfied.
However, many price review provisions are substantially more complex than
the Sonatrach contract. In addition (or as an alternative) to the passage of
time, the parties may require the occurrence of a specified event.
For example, the so-called ‘typical price review clause’, set out above,
requires the claimant to satisfy: first, the occurrence of circumstances
beyond the control of either party; secondly, that the circumstance results
in a significant change to the energy market of the buyer compared with
a specified date; and thirdly, that the price formula needs to be revised to
reflect that relevant significant change.
The so-called ‘typical price review clause’ is not the same as the price review
provision in the Atlantic LNG SPA, which requires: first, for either party to
consider that economic circumstances in Spain beyond the control of the
parties, while exercising due diligence, have substantially changed as compared
to what it reasonably expected when entering into this contract; and secondly,
that the contract price resulting from the application of the price formula does
not reflect the value of natural gas in the buyer’s end-user market.
In the Atlantic LNG SPA price review provision, unlike the so-called ‘typical
price review clause’, there is no express link between the change in economic
circumstances and the significant change in the energy market. Also, there38 Journal of Energy & Natural Resources Law Vol 30 No 1 2012 are no express words that require the tribunal to decide whether ‘the price formula needs to be revised to reflect that relevant significant change’. Instead, the provision jumps from the change in economic circumstances to whether the price reflects the value of natural gas. The three examples set out above illustrate different approaches to the drafting of the trigger element in a price review clause. There are many more.16 These very different formations of words are unlikely to have been intended to mean the same thing. The scope of a trigger event is a matter of agreement. Although relative competitiveness and structural market changes can create problems for long-term contracts, parties may choose to agree price review provisions that are triggered by other issues or events. In agreements that contain trigger events that require a change of circumstances, the satisfaction of that condition will be a mixed question of contractual interpretation and fact. This must be assessed on a case-by-case basis. However, the facts identified by Anthony Melling for the Carnegie Endowment for International Peace are a regular feature in the current round of reviews (growing liberalisation, liquidity and transparency in Europe; too much contracted/committed supply; uncertainty about demand, particularly in power generation; and second-tier players as emboldened insurgents). Scope of the tribunal’s mandate to revise In addition to the trigger event, the scope of the revision required by a price review provision can vary significantly. Again, the words used in the three examples set out above in the previous article in this series have little in common. Crucially, the arbitral tribunal will need to decide whether the words in the price review provision mean that it is mandated only to amend an existing price formula, so far as is necessary, to reflect the changes proven, or whether it is entitled to start with a blank sheet of paper. There can be a considerable difference between requesting an arbitral tribunal to make the minimum necessary revision to the existing bargain solely to reflect a significant change and requesting an entirely new price formula. If the arbitral tribunal is mandated to start with a blank sheet of paper, it will need to consider what (if any) guidance the parties have provided to ascertaining the new price formula. While price review clauses can be 16 Examples of provisions suggested by authors are: Energy Charter Secretariat, Putting a Price on Energy: International Pricing Mechanisms for Oil and Gas (2007), 155, Box 9 (‘Stylised Provisions of a Price Review Clause’); Susan Farmer, LNG Sale and Purchase Agreement, Liquefied Natural Gas, Paul Griffin (ed) (2006), 49; and Paula Hodges, LNG – a Minefield for Disputes?, Liquefied Natural Gas, Paul Griffin (ed) (2006), 115. The authors are aware of at least seven further variants published in publicly available sales and purchase agreements, arbitral awards and court judgments.
N atural Gas Price Reviews: Past, Present and Future 39 prescriptive, many parties agree to a wide formation of words to ensure that the remedies available to the arbitral tribunal can govern all possible circumstances. However, this is not always the case. If a wide formation is adopted, the arbitral tribunal may have greater scope to do what it considers to be fair and just in all of the circumstances. However, there is also a greater potential for an arbitral tribunal to recast the nature of the bargain in a manner that would never have been acceptable to one of the parties or that makes the contract uneconomic for one of the parties going forward. If this occurs, the arbitrators will have achieved the opposite of what the parties are likely to have intended. For this reason, in the event that the arbitral tribunal is mandated to start with a clean sheet of paper and is granted a wide formation, careful consideration of the relevant evidence will be required. Again, an arbitral tribunal will need to be careful not to ignore the words of the contract. These provisions vary and careful regard should be had to the requirements of the contract in question. This will often raise questions of contractual interpretation and construction. In this regard, in addition to the words of the price review provision, the following factors may be of some relevance: the existing (or original) price formula; the governing law; the arbitration provision; and the relationship between the price review provision, price formula and the rest of the agreement. Existing (original) price formula In answering questions of contractual construction, the arbitral tribunal might find useful guidance in the existing (or original) price formula. As set out above, the price formula will be the result of a negotiated compromise. The negotiation will have taken place at a specified time against the background of a range of factors that will have had an impact on the parties’ respective bargaining positions. However, the result of the negotiation will inform the arbitral tribunal on aspects of the agreed allocation of risk and value between the parties. Further aspects might be found in other sections of the contract (more of which below). Such agreed allocation at the time of the original agreement might assist the tribunal in its task of revision. Law governing construction and interpretation All of the above issues contain an element of contractual construction and interpretation. Therefore, the arbitral tribunal will need to establish the law governing the construction and interpretation of the contract.
40 Journal of Energy & Natural Resources Law Vol 30 No 1 2012 Sophisticated choice of law provisions usually extend to issues of construction and interpretation, which should provide the arbitrators with a direct answer. Although this is not always so. The law governing the construction and interpretation of the contract is likely to have an impact on the materials available to ascertain the meaning of the price review provision. This might extend to the admissibility of materials surrounding the agreement of the price formula. It will therefore be important to view the interpretation of the price review provision in the light of the law governing the construction and interpretation of the contract. Arbitration provision Natural gas agreements regularly provide for expert determination in relation to disputes over quantity or quality, so why not for price?17 Arbitrators will need to consider this question carefully, particularly when relying heavily on expert evidence in deciding issues of contractual interpretation. The inclusion of an arbitration provision for price reviews should suggest to the arbitral tribunal that the parties did not, at the time of drafting, perceive price reviews to be the sole domain of expert opinion. Expert evidence is often of great assistance in determining the parameters of relevant data and market practice. However, a price review arbitration is just that: an arbitration. It involves important elements of contractual construction and interpretation that should be the sole domain of the arbitral tribunal. If the parties had wanted an expert determination, they would have provided for one. Relationship between the price review provision, price formula and the rest of the agreement Price formulae and price review provisions are not negotiated in isolation. They are part of a wider transaction, which allocated risks and value between the parties. Price review provisions must be seen in this context. For most agreements, it would be wrong to assume that the price formulae and price review provisions were negotiated disregarding other key provisions such as quantity, quality, flexibility and interruptability. An arbitral tribunal should consider whether it is appropriate to have regard to these provisions 17 In fact, some of the old UK hardship provisions did provide for expert determination: see Superior Overseas Development Corporation and Phillips Petroleum (UK) Co Ltd v British Gas Corporation (above). In these circumstances, in the absence of an arbitration clause, the English Court of Appeal decided issues of contractual interpretation as a preliminary issue.
N atural Gas Price Reviews: Past, Present and Future 41 in seeking to construe the meaning of the price review provisions and the allocation of risk and value within the contract. In addition, it may be useful to understand the wide context of the transaction. For example, if the parties were aware that the sale and purchase agreement was to form security for project financing, the arbitral tribunal might need to consider the transaction in that context. The future Liquid markets The Anglo-Saxon system of natural gas markets based around geographical hubs or within-system wholesale trading markets has tended largely to reduce or eradicate the need for gas price review arbitrations between producers/ liquefaction companies and wholesale buyers in the United Kingdom and United States. This is because the majority of transactions in the United Kingdom and United States are carried out on relatively short terms, which means they are often marked to market directly and price review clauses are largely unnecessary. Many remaining strategic long-term commitments are primarily indexed to geographical hubs or within-system wholesale trading markets. Where this occurs, the long-term price ought to remain competitive and reflect the value of the commodity between a seller and a wholesale buyer in that geographical market. The development of such markets outside the United States and the United Kingdom ought eventually to result in the end of gas price reviews in markets where price is marked to market in real time. But will this happen? The development of open and competitive gas markets requires a number of factors to be present: • A government willing to create the legal infrastructure and market conditions for liberalisation. • A multitude of sellers willing to transact on a short-term basis and compete on price. • Sufficient quantities of supply to ensure that buyers do not need the security of long-term commitments. The European Commission maintains a vision of a ‘single, competitive and well-functioning European energy market’,18 which would replicate the 18 Neelie Kroes, Introductory Remarks on Final Report of Energy Sector Competition Inquiry, dated 10 January 2007. Available at: http://europa.eu/rapid/pressReleasesAction. do?reference=SPEECH/07/4. In addition, see Regulation (EU) No 1227/2011 of the European Parliament and of the Council of 25 October 2011 on wholesale energy market integrity and transparency, which states: ‘It is important to ensure that consumers and other market participants can have confidence in the integrity of electricity and gas markets, that prices set on the wholesale energy markets reflect a fair and competitive interplay between supply and demand, and that no profits can be drawn from market abuse.’
42 Journal of Energy & Natural Resources Law Vol 30 No 1 2012
Anglo-Saxon system throughout the European Community. If this vision is
realised, the entire Atlantic Basin (Europe, the United States and the United
Kingdom) will become dominated by liquid hubs trading on a short-term basis.
The current excess of supply of natural gas has created conditions in
the Atlantic Basin that are conducive to the development of price liquidity.
As wholesale purchasers (buyers) have sought to offload excess purchases
and producers/liquefaction companies (sellers) have sought a market
for new supplies, the market for spot trades and swaps within the Atlantic
Basin market has boomed. Lawyers have experienced a rapidly increasing
demand for master spot sales agreements, which create a legal framework for
counterparties to trade gas on a spot basis. These spot trades have developed
their own pricing dynamic, which has little (or no) relationship with existing
long-term pricing mechanisms.
In addition, the commissioning of new liquefaction facilities and the
movement in the United States towards shale gas raise the prospect of
additional volumes of natural gas entering the market.19 This would increase
liquidity and perhaps advance the prospects of a liquid Atlantic Basin gas
market developing.
In short, the market conditions in Europe have some striking similarities
to those in the United States in the 1980s and the United Kingdom in the
1990s, leading some commentators to predict the end of long-term oil
linked-pricing.
Countervailing forces
However, many of the factors evident in the Atlantic Basin cannot be said of all
parts of the world. The Pacific Basin market remains dominated by long-term
gas sales agreements that are largely linked to Japan Crude Cocktail (JCC).
Anecdotal evidence suggests that the Pacific Basin has not shared the appetite for
liquidity with the Atlantic Basin. Although the coming on stream of significant
production facilities in Qatar and Australia has increased supplies, the Chinese
economy remains a growth market that is able to accept excess quantities.
In addition, Atlantic Basin buyers might seek to maintain a number of
strategic long-term natural gas sales and purchase agreements to guarantee
19 ‘Shale gas has turned the American energy market on its head. Production [of
shale gas] has soared twelvefold since 2000, to 4.9 trillion cubic feet, or a quarter
of the country’s total gas output. By 2035 the proportion could rise to half. As the
shale gas flows, prices have come crashing down. Not long ago, America depended
on imports of liquefied natural gas. Now it is likely to become a gas exporter’, The
Economist, 26 November 2011. See also ‘US Shale Gas Bonanza: New Wells to Draw
on’, Financial Times, 5 October 2011.N atural Gas Price Reviews: Past, Present and Future 43 security of supply. These strategic long-term agreements may maintain oil- indexation if sellers are able to exert sufficient commercial leverage to impose this on buyers or if buyers perceive an advantage in a diverse portfolio that contains an element of oil-indexation. There are also a number of other factors that mitigate against the prospects of a fully functioning liquid market for natural gas: • Nuclear rethink: a number of countries are currently rethinking their nuclear energy policies. If this results in a movement away from nuclear energy it is likely that the capacity shortfall will have to be made up by constructing additional natural gas combined cycle gas turbines (CCGTs). This might have the impact of soaking up additional natural gas capacity and switching bargaining power in favour of producers. • Dominance of suppliers: in reality, many regional markets are still dependent on one or several critical suppliers. There must be a concern that these suppliers would control a sufficient proportion of sales to be able to dictate a regional hub price by controlling the volumes supplied to the hub at any particular time. As most of these critical suppliers are resident outside the reach of European Union (EU) and US authorities, it is difficult to see how anti-monopoly laws could effectively be employed to prevent anti-competitive behaviour. • Differing world views: while the United States and EU might share a vision of an Anglo-Saxon fully functioning market for natural gas; this view is not shared by all other importing countries. Nor do producing states perceive any benefit from a movement towards fully liquid markets, which would deprive national champions of long-term sales at stable prices. It must be doubtful that the United States and EU could impose their view on gas pricing on the rest of the world. On this basis, there appear to be serious obstacles to the development of a series of liquid spot markets for natural gas, which would be likely to be the end for most long-term contracts and price reviews. However, a middle way is possible. The market might move towards a more mixed model of increased trading liquid hubs accompanied by the continuation of a significant number of long-term strategic contracts. If the price formulae in these long-term contracts are partially linked to regional hub prices, the prospects of a misalignment between the long-term contract price and market fundamentals is to some extent decreased. In doing so, the likelihood of price reviews would also be decreased. Even so, they might still occur from time to time – depending on what the price review provisions in question were intended to achieve.
44 Journal of Energy & Natural Resources Law Vol 30 No 1 2012 Summary There are varying views on whether long-term gas supply contracts with price review clauses will still exist in many markets in ten years’ time. The lack of agreement between commentators reflects a difference in vision for the future of natural gas. In ten years we may yet be here again. In the interim, arbitral tribunals should keep in mind that price review clauses vary. In deciding disputes, a focus on the words of the contract in dispute will be essential. Approaching price reviews in a homogenised way raises the risk of failing to take into account the individual features of the price review provision and the wider bargain agreed by the parties.
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