In recent years there have been a number of significant commercial and technological developments in the LNG market. These developments have affected pricing, patterns of supply and demand, and the potential for exploiting new sources of energy. In this article, Carol Mulcahy considers the nature of those developments and some of the challenges faced by clients and their advisers as they deal with the management of LNG disputes in an evolving market.
Changes in the LNG market
The sale and purchase of LNG has historically been characterised by long-term contracts under which, for reasons of stability, the formula for the price to be paid for the gas is linked to the price of oil. At the same time, “price review” clauses contained various forms of trigger and criteria against which a base price could be adjusted.
The traditional pricing mechanism worked relatively well for a long time. However, as an independent market for gas pricing has developed, there has been a growing erosion of the link between the “market” price of gas and the oil-related pricing of long-term contracts. This has given rise to a spate of price-review arbitrations with buyers triggering price review provisions in the hope that they can persuade an arbitrator to adjust the contractual pricing mechanism.
Shifting patterns of supply and demand
There have been important changes in patterns of supply and demand brought about by regional economic development and technological advances. Traditional exporters and importers are shifting ground, the gap between supply and demand sources is reducing both physically and technologically, and new players are emerging across the globe.
At the same time, technological developments, particularly around shale gas, have the potential to significantly increase US domestic production of natural gas and to make the US an important future source of LNG for the global export market. Canada is expected to contribute to this trend whilst Australia and East Africa are also expected to deliver substantial quantities of LNG into the market.
Other important areas of potential change include: the development of new gas trading hubs - generating prices that reflect regional supply and demand and contributing to the emergence of a credible spot and futures market in LNG; and the trend towards decoupling production and transportation as a means of increasing competition and increasing security of supply.
All of these factors have an impact on price, volume of available supply and contractual arrangements. Changes include an increased use of spot or short-term contracts, a move from DES to FOB contracts and more flexible pricing mechanisms.
What does all of this mean for disputes in the LNG sector?
The journey towards greater flexibility and commercial opportunity will not be trouble free.
Environmental concerns around the production of shale gas, such as a perceived threat of contamination of aquifers, have the potential to fuel claims or objections to production. New technologies associated with production may also lead to an increase in technical disputes. Commercial arrangements will need to address agreements between landowners and producers on such matters as mineral rights, access rights, royalties and other forms of compensation.
The difficulties in decoupling production from transmission are illustrated by the recent Gazprom/Lithuania investment dispute and there is clear potential for increased investor-state disputes. Newly emerging producers, such as Tanzania, are likely to want to encourage foreign investment in physical infrastructure and technology whilst ensuring that they reap appropriate rewards from national resources. Achieving an appropriate risk-reward balance between state and investor in such cases is likely to be challenging.
Dispute resolution mechanisms in the energy sector tend to be sophisticated and robust with disputes generally being resolved by international arbitration. Nevertheless, in a fast evolving market, it becomes even more necessary at the contract drafting stage to pay proper attention to the dispute resolution provisions by reference to the facts of the transaction, rather than to adopt pre-drafted, boilerplate provisions.
Specific points to consider include:
- Whether there are categories of technical issues that, if in dispute, may be more efficiently carved out to expert determination rather than arbitration.
- Whether to build in a form of interim adjudication that will enable the parties to move on with a project in the event of a dispute.
- Whether it is desirable to include an express provision for mediation or conciliation as part of a wider commercial strategy to maintain good long-term relations.
- Whether the transaction documents have been constructed in such a way as to satisfy the requirements of (and benefit from) investor-state protection. For example, does the state in which the corporate investment vehicle has been incorporated have an investment treaty in place with the host state? Is the host state, and the investor state, a party to the ICSID Convention? Do the contract documents include the necessary expression of consent to an ICSID arbitration by the host state (or agency) if this is not expressly provided for in the relevant treaty?
- Where the transaction involves the placing of physical assets in a foreign jurisdiction what impact is the local law likely to have on the governing law of the contract chosen by the parties.
- Whether there is potential for overlapping disputes under different but related or dependent contracts or transactions and how this can be managed – for example by having consistent dispute resolution provisions.
A fuller version of this article was published by Taylor & Francis in the Journal of Energy & Natural Resources Law on 17 July 2015, available online: http://www.tandfonline.com.