The fall in oil prices and the consequent reduction in capital expenditure by oil and gas companies means many projects will not go ahead as planned. Yet extricating a company from a project in which contracts have been signed can be very difficult. Below is an essential four-step strategic approach to the complex issue of contract terminations.
It is now starkly apparent that the dramatic collapse in the oil price has led to a significant reduction in investment in oil and gas exploration projects. If the market was in any doubt about this particular path of cause and effect, it was firmly underlined by Shell’s announcement at the end of January that it had decided to cut $15 billion in global spending, the majority of which had been allocated to new exploration and the development of oil and gas fields.
The four-step strategic approach.
Although this is an Operator case study, the fourstep strategic approach can be applied to any contractual scenario.
Step 1. Start with the contracts.
While this is an obvious statement, it is critical that the Operator, and players involved in projects of any nature, look at all their relevant contracts and gain a precise understanding of their terms with a particular focus on the termination provisions.
Step 2. Consider the commercial position.
Before considering taking more provocative, and ultimately risky, contractual steps, the Operator should consider whether it has any commercial leverage that it is able to use to persuade its partners to vary the terms of the agreements in its favour. There might be other business opportunities that the Operator could offer in exchange for flexibility.
Step 3. Contract discipline.
While the Operator is considering its options, it must ensure that it meticulously fulfils the terms of its contracts. It must not present its contractual counterparties with an easy opportunity to allege breach of contract by failing to meet its obligations. If such a situation was to arise, the Operator would be put on the back foot and lose the chance to take the initiative.
Step 4. Consider counterparty contractual performance.
The Operator should carry out a close analysis of each element of its counterparties’ contractual performance. Any apparent breaches of the terms of the contracts could either be used as negotiation leverage in discussions to amend the agreements or, if they are sufficiently serious, as grounds for termination, if commercial negotiations break down.
There can be no one-size fits all solution to how a party faced with an uneconomic project should proceed, but if they follow the four-step strategic approach, they give themselves the best chance of successfully negotiating the difficulties they face.