Gas Price Renegotiation: A Sign of the Times

The uncertain geopolitical landscape of today’s natural gas markets has led increasingly to renegotiation of long-term gas supply contracts.

Such contracts, which can be worth billions of dollars, often include price adjustment mechanisms which are intended to ensure that over the lifetime of the contract the contractual price can be adjusted to reflect changes in the market. Those mechanisms can provide for negotiations with a backstop of arbitration.

While negotiations will be the preferred method to respond to minor changes in the market, when market fluctuations are volatile enough one (or both) parties may be incentivised to push instead for arbitration. This may be a significant roll of the dice, and some recent arbitral awards show that arbitral tribunals are not afraid of determining the appropriate price in accordance with the underlying contract and price review mechanism.

Triggering of the price adjustment mechanism and the march to arbitration

Any significant market shift will lead to buyers or sellers across the market seeking renegotiation of price under long-term contracts. For example, recent reductions to gas spot prices have led buyers to seek to trigger price review mechanisms under gas supply contracts. Suppliers have either agreed to the price review or taken the disputes to arbitration. Further complications arise when such gas supply agreements include a “take or pay” condition,where the buyer pays the supplier for specified quantities of gas irrespective of the buyer’s needs.

There can be ambiguity as to whether a price review mechanism is triggered. Often such mechanisms are drafted in general terms in order to provide flexibility between the parties. However, the language surrounding the triggering of such a clause—and the point at which any dispute should be elevated from negotiations to formal dispute process such as arbitration—should be carefully drafted if the parties wish to avoid a lengthy dispute processes as to whether the clause is even engaged (and only then as to what the price should be).

Arbitration as an enabler for a continuing relationship

There are, or have been, a number of recent high-profile gas pricing disputes which demonstrate that commencement of arbitration can be one aspect of a negotiation process, or indeed can provide resolution of a valuable dispute by a neutral panel which allows the parties to carry on with performance of a long term contract.

For example, the Turkish pipeline operator BOTAS has been reported as having brought a claim against the National Iranian Gas Company in 2005 for alleged refusal to lower gas prices despite low production rates and poor quality product. That arbitral procedure took four years, at which point the arbitral tribunal issued an award in favour of BOTAS for US$760 million. From publicly available information, those companies continued their contractual relationship following that arbitral award, and more recently a second arbitration was commenced by BOTAS in January 2012 under the same underlying agreement. That second arbitration remains on-going.

This story is not unique to that case and as many buyers and suppliers under long-term gas supply contracts will know, arbitration can be a somewhat costly but otherwise helpful neutral process by which a dispute as to pricing can be resolved, otherwise allowing the parties to carry on with their contractual arrangements.

While arbitration can be a useful neutral mechanism, parties will be wary of arbitrators becoming overly assertive in applying a new or different formula which goes beyond what the parties originally negotiated or envisaged.

For example, the decision in a recent case of Rasgas v. Edison LNG (2012) indicates that tribunals are ready to depart from the wording of a gas supply contract, particularly where the contract price is linked to the price of oil. It is difficult to analyse and draw conclusions as the award and the relevant contracts are confidential. However, at first glance, it appears that this decision has caused justifiably concern for the parties, in particular suppliers.

Similarly, in Atlantic LNG Company of Trinidad and Tobago v. Gas Natural LNG SPA (2008), the arbitral tribunal came up with a two-part pricing scheme and imposed its own preferred pricing structure, which neither party requested or desired.

Recently, in partial award of BOTAS Petroleum Pipeline Corporation v. the National Iranian Gas Company (2014), the tribunal dismissed BOTAS’s claim that the NIGC failed to meet Turkish gas demands and thus sought both specific performance and a US$13 billion price cut on that basis. The second claim of US$25 billion, for reduction in the price of gas on the basis of a price revision clause, is yet to be ruled upon by the tribunal.

Is arbitration still the answer?

Arbitration is still often the best, or at least a very good, answer in disputes under gas supply agreements. An arbitral tribunal, operating under terms of confidentiality and with (often) ready access to party appointed expert witnesses, is often able to cut through procedural issues and focus on underlying commercial rationale.

While this can have its own dangers when arbitrators seek to impose a result which neither party envisaged or asked for, more often than not it can mean that the parties’ dispute can be determined by a neutral panel while the parties carry on with the performance of their long-term contract, rather than suffer the paralysis of all-out litigation war. Finally, international arbitral tribunals can offer a neutral venue as compared to national courts, in a sector and type of dispute where commercial and political-economic interests can overlap and draw out nationalist reactions.

In order to protect themselves from the uncertainty in the enforcement of the gas price review clause, parties should:

• Appoint appropriate arbitrators with extensive knowledge of the gas supply market, its prices and formulae;

• Ensure that the arbitration agreement clearly defines the extent to which arbitrators can depart from the contractual formula for determining price. It should also define the boundaries of the arbitral tribunal’s jurisdiction to exclude the application of a hybrid formula to determine the price;

• Consider the use of so-called “high-low” or “baseball” arbitration. This is where the parties privately agree to the potential price range. The arbitral award then binds the parties unless it exceeds the upper limit or is less than a lower limit. In a baseball arbitration, each party proposes a monetary award to the arbitral tribunal and the tribunal simply chooses between the parties’ respective positions without any modification;

• Choose a governing law which would give effect to the gas supply agreement and reduce the likelihood of the arbitral tribunal finding against the bargain of the agreement; and

• Explore the possibility of having different arbitration clauses in one gas supply agreement for the price revision disputes (preferably a three member tribunal) and for disputes relating to the quality, conditions, and other disputes (preferably a sole arbitrator).

Joe Tirado

Mr Tirado is a partner and a Co-Chair of International Arbitration Practice at at Winston & Strawn. 

For more information, please contact Joe Tirado (jtirado@winston.com) or your usual Winston & Strawn lawyer.