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The Guide to Energy Arbitrations - Second Edition

Gas Price Review Arbitrations: Certain Distinctive Characteristics

Long-term gas supply agreements (GSAs) often provide for the sale and purchase of very large quantities of gas or LNG over a period of 20 years or more. Given the long supply period, parties rarely agree to buy and sell gas at a fixed price. Instead, they typically provide for a formula for calculating the price of gas by reference to one or more indices including, at least historically, the indices for the price of oil or oil products. While an indexed price formula provides some pricing flexibility over time, it can be insufficiently responsive to market dynamics over the term of a GSA. In particular, during that period, circumstances may change in a manner that would cause the contract price formula to no longer reflect the ‘fair market’ or ‘competitive’ price in the relevant market. That is why most long-term GSAs also contain a price review clause that allows the parties to periodically (often, every three years) request a review of the contract price formula to ascertain whether it should be adjusted in response to changes in the market.

Typically, GSAs contain a mandatory negotiation period of several months during which parties must discuss their differences in order to seek an amicable settlement. It is only if parties are unable to reach commercial agreement during this period that a price review ends up in arbitration (given the confidential nature of these disputes, it is rare to see them referred to national courts for resolution). Most price reviews were historically resolved at the negotiation phase and rarely submitted to arbitration. However, there has been a notable increase in arbitrations involving European gas markets in recent years, suggesting that buyers and sellers are finding it difficult to resolve their differences through negotiations.

That has been the case primarily because these negotiations have been taking place against a varied background, including:

  • fall in gas demand in many markets as a result of the financial crisis that began in 2008;
  • regulatory and structural changes in European markets, including the emergence of liquidly traded gas hubs (which undermined the traditional link between oil and gas prices);
  • competition from other sources of energy, including renewable energy;
  • global oversupply, in particular the impact of shale gas in the US; and
  • large fluctuations in oil prices.

The effect of these changes, and others, continue to be felt, and therefore there are likely to continue to be substantial number of price review disputes in the near future.

Although these disputes are resolved in arbitration, they are not like other arbitrations. Given the prevalence and commercial importance of these disputes – even a relatively minor change in the contract price, when multiplied by the large volumes to be delivered over a number of years, can have a significant financial effect on the buyers and sellers – it is important to understand how gas price review arbitrations can differ from other arbitrations.

In this chapter, we identify five such differences. As explained below, these differences exist primarily because of the nature of the underlying dispute (which, unlike traditional disputes, does not involve any allegations of a legal wrong or a breach of contract), the commercial context of the arbitration (which, in turn, requires arbitrators to adopt a more commercial approach and the experts and parties to be more closely involved) and the recurring nature of these disputes within the confines of a single agreement (which raises particular issues in respect of confidentiality and the binding nature of past determinations).

Distinctive characteristics of gas price review arbitrations

Different nature of the dispute

Typically, a commercial arbitration arises from allegations that one party has breached a term of the contract or failed to fulfil some other legal obligation. An arbitration tribunal has to determine which party is legally at fault and, if so, the compensation due to the innocent party. By contrast, in price review arbitrations, these issues are not usually relevant (save, perhaps, for arguments over whether a party has complied with the procedural requirements for triggering a price review). Instead, arbitrators are usually asked to determine whether the contractually stipulated criteria for an adjustment of the contract price formula have been satisfied and, if so, what that adjustment should be. Given that by the time the parties submit their dispute to arbitration they have already (unsuccessfully) attempted to resolve these issues, the arbitrators are effectively asked to find a commercial solution that the parties failed to agree on during the mandatory negotiation period.[1]

To fulfil this mandate, arbitrators have to perform a somewhat different role in gas price review arbitrations, when compared to the role they typically perform in other arbitrations. First, they need to understand the commercial (rather than purely legal) context of the dispute. GSAs are relational contracts and the parties are ultimately interested in maintaining their long-term commercial relationship. The tribunal must therefore try and find a solution that is acceptable, and economically sustainable, for both parties. The tribunal must do so while at the same time interpreting and applying the relevant provisions of the GSA and following the governing law of the contract.

Second, arbitrators need to understand at least the basics of gas pricing and the role they are being asked to perform. Commercial arbitrators are skilled at evaluating complex factual evidence and applying that evidence to the law. That ability is less relevant in the context of gas price review arbitrations which rarely involve large amounts of factual evidence or lengthy submissions on legal issues (although, as discussed below, these arbitrations often involve complex contractual interpretation issues). A failure by a tribunal to adjust its mindset to the requirements of a price review can lead (and has led) to highly unpredictable and commercially unsatisfactory awards.

Finally, and this follows from the points made above, arbitrators have to temper their style of decision-making in the context of a gas price review arbitration. In particular, given the need to find a commercial solution that is acceptable to both parties, in our experience, the best arbitrators often approach these disputes from a less legalistic, and more commercial, perspective than would normally be the case in a commercial arbitration.

Common interpretation issues

Although the wording of price review clauses often varies in material ways, they tend to have a similar structure. Broadly speaking, a price review clause will set out: the circumstances that permit a price revision (the trigger); the factors to consider when adjusting the price formula; and the procedure for requesting a price review.

As far as the trigger event is concerned, different clauses take different approaches to when a party can request a price review. At one end of the spectrum are clauses which provide that the parties will meet at fixed intervals to discuss revisions to the contract price. For example, the GSA between Sonatrach and Distrigas signed in 1976 simply provided that the parties will meet ‘every four (4) years’ to discuss price revisions.[2] Such clauses eliminate any interpretation issues at the trigger stage of the price review. Another way to limit interpretation difficulties is to provide for mechanical trigger criteria. For example, the GSA in Esso Petroleum & Production UK Limited v Electricity Supply Board required that the contract price must deviate from the market price by a fixed percentage before the price can be reopened.[3]

However, these formulations are uncommon. Price review clauses typically require the requesting party to show that certain qualitative changes have occurred in the relevant market which merit revision of the price formula. In particular, they usually require the requesting party to establish that:

  • a ‘significant’ or ‘substantial’ change has occurred in the ‘buyer’s market’;
  • the change occurred before the ‘review date’;
  • the change was beyond the control of the party requesting a price review; and
  • the change must have, or be likely to have, an effect on the market value of gas in the buyer’s market.

A good example of this approach is the Atlantic LNG – Gas Natural GSA, which provided that the requesting party must show 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 the Contract Price . . . does not reflect the value of natural gas in the Buyer’s end-user market.[4]

In addition to setting out the trigger event, a price review clause may also indicate the relevant criteria needed to adjust the price formula. This could include: a requirement that the price must allow the buyer to ‘economically market’ the gas purchased;[5] or a reference to other prices as comparators, such as prices under ‘comparable contracts’ or prices in the end-user market.

As a result of these similarities in structure and, to some extent, wording of the price review clause, the same interpretational issues tend to arise repeatedly in these disputes. For example, common debates arise out of the meaning of words and phrases such as ‘significant’, ‘value’ and ‘economic circumstances’, as well as factual disputes regarding, for example, whether changes were foreseeable or beyond the control of the party requesting the price review.

At the adjustment stage, to the extent the price review provision refers to a buyer’s ability to ‘economically market’ the gas, questions often arise as to what that phrase means. For example, does it mean that, irrespective of market conditions, the buyer should always be entitled to make a net profit on the gas that it on-sells? If so, at what level should that profit be fixed? Similarly, if the tribunal is required to consider prices in ‘comparable contracts’, a question often arises as to what ‘comparable’ means. Should the tribunal be restricted to, for example, comparing prices under other long-term LNG contracts only, or can it also consider prices under long-term contracts for pipeline gas and short-term (spot) contracts for the sale of LNG? Aside from the interpretation difficulty, this analysis is further complicated by the fact that, as explained below, the relevant data is rarely available because most LNG and pipeline gas contracts contain strict confidentiality clauses and the terms are not in the public domain.

The list of issues highlighted above is by no means exhaustive: there are many other interpretation issues that arise again and again in gas price review arbitrations.[6] That is partly because similar clauses seem to be reused as standard in GSAs. In that sense, gas price review arbitrations are similar to investment treaty arbitrations. Investment treaty tribunals have to often grapple with the same treaty interpretation issues that previous tribunals have already considered. Again, that is the mostly due to similarities in the wording of the bilateral investment treaties. That said, the task of an investment treaty tribunal is aided by the availability of a large corpus of publicly available awards to which it can refer while deciding a particular dispute. However, as explained below, that is not the case with gas price review arbitrations.

Role of experts

Experts are frequently used in commercial arbitrations. In most cases, expert testimony is adduced where either the quantum of damages is a contested issue (e.g., in expropriation cases) or where industry standards and conduct are in question (e.g., in construction disputes). In these cases, while the role of an expert is crucial, it is often not central to the resolution of the dispute because the tribunal has to grapple with complex factual and legal issues before turning its mind to the expert testimony. For example, expert evidence on quantum is only relevant where the tribunal has found a breach of a legal obligation requiring the payment of damages; in the absence of that finding, such evidence is largely useless.

By contrast, experts play a central role in gas price review arbitrations.[7] Expert evidence often runs into hundreds of pages, setting out, among other things: the economics of the parties’ transaction (e.g., explaining the take-or-pay obligations under the GSA); analysis of the ‘trigger’ criteria (e.g., whether or not there has been a change in circumstances that meets the contractual criteria); and the appropriate level of ‘adjustment’ (in case the tribunal finds that the criteria for triggering the price review have been met). In fact, experts usually provide the majority of the evidence in a gas price review arbitration: factual witness statements are rarely submitted and, even if they are, they are often limited to short accounts of pre-contractual negotiations (a party may wish to explain the circumstances in which the GSA was concluded) or pre-arbitration negotiations (a party may wish to explain how it followed, or the other party failed to follow, contractually required procedures before commencing arbitration).

Moreover, legal submissions in gas price review arbitrations largely track the expert evidence. Although these arbitrations often involve complex contractual interpretational issues – and, as explained above, the same issues tend to arise again and again – the focus of the legal submissions is on explaining whether the trigger criteria have been met and, if so, the level of adjustment to which the requesting party is entitled. That, in turn, requires describing the alleged changes in economic circumstances, assessing them against specified criteria and reflecting the effect of those changes in the adjusted price formula (to the extent the adjustment criteria is expressly linked to the trigger criteria). Because these are mostly questions for the expert, legal submissions tend to largely focus on the evidence contained in the expert reports.

Finally, given the volume of expert evidence, at the hearing, a majority of the time is unsurprisingly spent on expert testimony, rather than testimony from factual witnesses or the presentation of legal submissions. By contrast, in many commercial arbitrations, relatively little time is reserved for expert testimony at the hearing.

Confidentiality

Confidentiality is a hallmark of international arbitration. Generally speaking, arbitration proceedings are conducted in private, which means that only the parties involved in the proceedings are allowed to attend the hearing and only they are provided with access to all the information emanating from the arbitration, including the award of the arbitral tribunal. By contrast, judicial proceedings take place in open court. The resulting publicity may not be desirable for disputing parties and hence the confidentiality offered by arbitration is often viewed as one of the key advantages of arbitration over litigation.

In the context of gas price review disputes, the confidentiality afforded by the arbitration process is even more important as the contract price is among the most sensitive information in the gas industry. Of course, confidentiality itself does not distinguish a gas price review arbitration from a commercial arbitration. However, its effect is felt rather differently. Confidentiality issues tend to arise at all stages of gas price review disputes, including during pre-arbitration negotiations, during the arbitration itself and after the arbitration has ended.[8]

As for pre-arbitration negotiations, often they involve parties exchanging views and information on various issues, including the relevant trigger events and the appropriate level of adjustment to the contract price formula. During the negotiations, parties frequently make concessions to reach a mutually acceptable solution and avoid arbitration. Positions taken by a party during these negotiations, however, may be different to the position it wishes to adopt in the arbitration. There is, therefore, a risk that parties may try to use information exchanged during the negotiations in any subsequent arbitration. To avoid that risk, such negotiations are often conducted on a without-prejudice basis. In addition, the parties may enter into specific confidentiality agreements, either in the original GSA or in any subsequent agreement, to ensure that the information exchanged will not be used in a subsequent arbitration.

Next, during the arbitration, confidentiality may have a significant effect on how the parties argue their respective cases. As noted above, price review clauses often require tribunals to adjust the contract price by taking prices in comparable contracts into account. However, pricing information is usually confidential and, therefore, there may not be much publicly available evidence for the tribunal to draw upon. In the absence of information from contracts of third parties, one of the parties to the dispute may want to rely on its own prices in the market. For example, the seller may have multiple buyers in the market and could disclose prices under those contracts to give the tribunal an idea of the prices at which other buyers, in that moment, are buying gas. Similarly, the buyer is likely to know the prices end-users in the market pay for gas, as these end-users will often be its customers. The exclusive access to some of the pricing information leads to an asymmetrical situation: the buyer and seller have access to pricing information which the other party does not have access to and accordingly they may decide to use that information selectively (i.e., only when it is helpful to their case).

This information asymmetry can be addressed if the parties are required to disclose their prices. However, because these prices are set out in contracts that often contain confidentiality provisions, it may not be possible to compel disclosure. As a result of these restrictions, very often the only evidence of prices on which the parties and the tribunal rely are publicly available information, even though such information may not, in some markets, be as reliable or complete as pricing information held by the parties.

Finally, the award issued by the tribunal in gas price review arbitration, as in any other commercial arbitration, remains confidential. In the ordinary course, this is rarely an issue because every commercial dispute is likely to involve unique issues of fact and law, and past awards are, therefore, of limited interpretive value to future arbitrations. That, however, is not the case with gas price review arbitrations which, as noted above, tend to involve similar interpretational issues. As such, access to awards rendered in gas price review arbitrations could be very useful.

Because parties are unlikely to disclose their awards voluntarily, there are primarily three avenues through which such awards may become available: when one of the parties to the arbitration is making a stock market announcement (there is usually a duty to disclose at least the result of the arbitration if that result could have an effect on the share price); when the award is being challenged or enforced in a domestic court; and extracts from the award may be published, after redacting names of the parties and other sensitive information, in the relevant arbitration institution’s bulletin.

Thus, one of the best known gas price review awards – the Atlantic LNG award[9] – became public when both parties to the arbitration decided to challenge the award in US federal courts. There are also two well-known International Chamber of Commerce (ICC) awards, from 1999 and 2007 respectively, regarding the same long-term gas supply agreements; extracts of these awards were published in the ICC Bulletin in 2009.[10] Because these three awards are rare examples of publicly available awards rendered in gas price review arbitrations, they have assumed far greater influence than they otherwise would, and are often cited by counsel in their submissions and by arbitrators in their awards.

Forward looking nature of these disputes

Typically, commercial arbitration, like commercial litigation, is a backward-looking process that hinges on the tribunal (court) awarding damages to the claimant for a breach that occurred in the past. In doing so, the arbitrators only have to consider events leading up to the date of the breach as that is usually the date by reference to which damages are assessed. In particular, the tribunal does not have to concern itself with events post-dating the breach, let alone events that might post-date the award.

Gas price review arbitrations, on the other hand, require the tribunal to exercise both backward-looking and forward-looking judgment.[11] The purpose of a price review is to fix the contract price formula as of a specified ‘review date’. To do so, the tribunal has to first determine whether a triggering event occurred at or before the review date. Therefore, strictly speaking, changes that post-date the review date are not relevant: those changes are for the next price review, and taking them into account in an earlier price review risks double-counting them in both the current price review and the next. In that sense, when it comes to establishing whether a triggering event has occurred, tribunals are expected to exercise backward-looking judgement only.

Next, if the trigger is established, the tribunal must adjust the contract price formula in accordance with specified criteria. While these criteria differ from contract to contract, broadly, a price review clause would either try to relate the price revision to the change that triggered the review or it would not. In the former case, the task of the tribunal is to determine the value of the change, whereas in the latter case its task is to determine the value of the gas. In both cases, the adjustment has to be made by reference to the review date (i.e., the revised contract price should reflect the value of the change or the value of the gas as of the review date).

However, it is possible that the energy prices will rise between the review date and the hearing date, which gives rise to the perception that a higher contract price is justified, or vice versa. It can be difficult for a tribunal to avoid those perceptions, especially where the triggering events that occurred during the price review period suggest the opposite. The tribunal is also likely to be guided by its mandate to find a solution that is commercially acceptable to both parties: it may be, therefore, reluctant to set a price that completely ignores changes in market prices post-dating the review date (although whether it has the mandate or even the jurisdiction to take these factors into account can be called into question). Further complications can arise if the clause requires, for example, the effect on the value of gas to be expected to have an enduring effect, which requires some prescience on the part of the tribunal.

Conclusion

While gas price review arbitrations are a subset of commercial arbitrations and therefore share some of the characteristics of commercial arbitrations, they are in many respects quite different. In this chapter, we have identified five important differences. Ultimately, the key difference relates to the nature of the underlying dispute: by requiring the tribunal to find a commercially acceptable solution so that the long-term relationship under the GSA can be continued, the parties essentially require the arbitrators to perform a role that is very different to the role that they normally perform. Because arbitrators have to adopt a commercial approach to their decision-making, they unsurprisingly rely heavily on testimony provided by experts, who play a central role in these arbitrations. The other differences identified above are also largely a manifestation of the unique context in which gas price review arbitrations are conducted.

This list of differences is, however, not exhaustive. For example, we have not discussed some of the procedural challenges that one tends to encounter in these arbitrations (e.g., issues relating to timing and content of review notices) or the effect of the principles of res judicata and issue preclusion. (Given that the same interpretation issues are likely to arise each time there is a new price review under the same contract, arbitration tribunals have to decide what weight, if any, should be given to determinations made by prior tribunals.) It is also important to note that these differences are a matter of degree: for example, it is possible that some of the confidentiality issues identified in this chapter may not be relevant to a given gas price review arbitration, particularly if the market in question is more transparent than usual.

Given the recurrent nature of the issues discussed in this chapter and the increasing frequency of these disputes, one might have expected some kind of industry consensus to emerge. To date that has not happened. And with the polarisation of the position between buyers and sellers, perhaps that is inevitable. Whatever the reasons, the effect has been the adoption of a wide of variety of approaches by tribunals in price review awards. That in turn creates unpredictability, risk and, in some cases, deep dissatisfaction with the process. It remains to be seen whether the end-users of the arbitration process, the industry clients, remain content to allow their valuable contracts to be subject to such vagaries, or whether we will see a move towards an industry consensus as to how some of these issues should be addressed. In our view, such a move would be most welcome.

Notes


[1]    See George von Mehren, ‘The Arbitrator’s Role’, in Gas Price Arbitrations (ed. Mark Levy, 2014), p. 91.

[2]    The Sonatrach – Distrigas SPA (1976) is available at www.fossil.energy.gov. Distrigas Corporation Docket No. 88-37-LNG, Exhibit E-1: Agreement for the Sale and Purchase of Liquefied Natural Gas of 13 April 1996.

[3]    [2004] EWHC 723 (Comm).

[4]    Terms of the Atlantic LNG GSA became public when the arbitration award in the underlying arbitration – Atlantic LNG Company of Trinidad & Tobago v Gas Natural Aprovisionamientos SDG SA, UNCITRAL, Final Award dated 17 January 2008 – was challenged in US federal courts.

[5]    This clause, which is also referred to as the ‘any case’ clause, often reads as follows: ‘[Whatever adjustment is made] in any case the buyer should be entitled to market the gas economically’.

[6]    For more examples, see Mark Levy, ‘Drafting an effective price review clause’, in Gas Price Arbitrations (ed. Mark Levy, 2014), pp. 9–20.

[7]    See Colm Gibson, Boaz Moselle, ‘The role of an expert in price review arbitrations’, in Gas Price Arbitrations (ed. Mark Levy, 2014), p. 118.

[8]    See Philippe Pinsolle, ‘Confidentiality in gas price reviews’, in Gas Price Arbitrations (ed. Mark Levy, 2014), pp. 47-61.      

[9]    Atlantic LNG Company of Trinidad & Tobago v Gas Natural Aprovisionamientos SDG SA, UNCITRAL, Final Award dated 17 January 2008.

[10]   ‘Extracts from the ICC Arbitral Awards: Price Setting and Price Revision in the Energy Sector’, in ICC International Court of Arbitration Bulletin, Vol. 20/2, 2009, pp 69-76 and 93-109.

[11]   See David Mildon, ‘The adjustment phase’, in Gas Price Arbitrations (ed. Mark Levy, 2014), p. 134.

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