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The Guide to Energy Arbitrations - Second Edition

Gas Price Review Arbitrations: Changing the Indexation Formula

In the first edition of this book, the author illustrated his experience of gas price reviews and, in particular, the key factors required to properly run the process.[1] The intention was to help arbitrators involved in price review proceedings to implement a methodology to resolve those controversial and decisive issues they inevitably have to cope with, and to take the right direction at any crossroads that would be decisive for the case. It derived from the development of the first two rounds of price reviews that took place in continental Europe from 2010 to 2015 and that were all based mainly on the decoupling of the oil and market prices.

Rather than rising or falling at the same pace, as had usually happened before the first round of arbitrations, oil prices started to rocket in 2010 (before beginning a rapid descent in autumn 2014) while gas market prices decreased. This amplified the negative difference between the prices at which the gas could have been resold by buyers in the market and the contract sales price of the gas, which was indexed to oil prices.

A third round of price reviews commenced in 2015 in an environment of unusually low oil prices and resulted in a series of awards in favour of the buyers.

If the two first rounds of price reviews generally sought a review of the ‘P0’ element of the contract sales price, the new generation of reviews seems to be different. The main reason is that the contract sales prices in the existing long-term sales and purchase contracts were disconnected to the market prices and such disconnection was obvious with the occurrence of the decoupling. As already explained in the previous publication[2] this situation predominantly related to continental Europe and Asia.

At the outset of the gas industry in Europe, there was a need to link the contract sales prices to competing fuels in the absence of liquidity in gas trading markets. Following European gas market liberalisation and the subsequent creation of several gas trading hubs, where the gas prices reflect the market value of gas, this approach has become obsolete. Changing the indexation element of the contract price from oil to gas market prices has become key. This has been recognised by industry[3] and regulatory bodies.[4] This is also reflected in the new long-term gas sales and purchase contracts executed in the past few years, where price review clauses are no longer as relevant because the contract sales price has changed indexation formula from oil-linked to hub-priced.[5]

As well as its significance to the value of gas sale and purchase contracts, this also has implications for tribunals who have to decide on the methodology to adjust the contract sales price based on the indexation formula of P0 rather than on P0 only.

The issue of the power of the tribunal to change the indexation formula and not just the P0 element of the contract sales price was already briefly illustrated in the previous publication.[6] The scope of the present work is to dig into the details of several aspects involved in the price review process where a change in the indexation formula is requested.

Changing the indexation formula

Arbitrators deliberating on the change of the indexation formula of a long-term oil-linked gas sales and purchase contract do not face an easy task. It cannot be resolved in isolation without the assistance of the parties. The wording of the price review clauses in the existing long-term gas sales and purchase contracts entered into at the time of no gas-to-gas competition, which still predominate, form the basis for most of the problems.

These clauses were written in a very vague language and only thanks to the efforts of tribunals and practitioners has it been possible to identify a set of general rules of interpretation that constitute the basis for their enforcement. Nowadays these clauses appear to be outdated and unsuitable for the changing market. However, the tribunals in price review proceedings still have to interpret old clauses like the following:

Each of the Parties shall be entitled to request a revision of the applicable Contract Sales Price, provided that the market of the country of final destination of the natural gas shall undergo changes of such nature and extent that would justify a revision of the Contract Sales Price to enable the Buyer to maintain a reasonable marketing margin assuming the application of the principles of sound marketing practices and efficient management by the Buyer.

The main task of the tribunal is that of revising the contract sales price. In the gas industry, a price review is usually based on four (or sometimes three) steps, whereby the failure of the claimant, seeking either a reduction or an increase in the applicable contract sales price, to pass any step would bring the process to an end.

The first step, namely to determine if the significant changes have occurred during the review period, would remain the same, as it is not affected by the request to change the indexation formula. The claimant must always demonstrate that a ‘change’ to the market conditions has occurred.

The second step is to verify if, at the review date, such changes are not reflected in the contract sales price, and the third is to determine if the buyer is able to economically market the gas. As with the first step, these steps are not affected by a price review request seeking a change in the indexation formula. Indeed, the test necessary to run the check on steps two and three, namely the delta of delta test, is based on the value of the contract sales price against the market value of the gas in the given market. They are a matter of fact. It is a comparison between the contract sales price and the market prices at the beginning and at the end of the review period.[7]

Therefore, it can be assumed that, all the preconditions to change the contract sales price whether relating to the P0 element only or to the indexation formula as well, remain unchanged. They constitute the basis of the right of the claimant to have the contract sales price reviewed.

The most important difference is around the last step, when the arbitrators and the parties have to run the market test to change the contract sales price to determine what is the appropriate level of the contract sales price at which the buyer is able to sell the gas in the market economically, namely its reasonable margin. The obtainability test is a key factor in this process.[8] As the tribunal has to consider a change in the indexation formula and not just in P0, the preference to refer to the buyer’s actual obtained prices rather than to the prices obtainable in the market and therefore to disregard the market data of a hypothetical buyer, could be disputed.

If in the change of the P0 element only, preference must be given to the buyer’s obtained prices in the relevant market, when the indexation formula is challenged the validity of this approach becomes doubtful.

The change of the indexation formula requires eliminating in the contract sales price the reference to the oil basket indexation and to the P0 element as indicated below:[9]

Contract Sales Price = P0+(G-G0)+(LSFO-LSFO0)+(GR-GR0)+(HSFO-HSFO0)-BR

and replacing it as indicated below:

Contract Sales Price = TTF-D

The hub reference generally used in Europe is the TTF, though in some countries the increasing liquidity of the gas markets has created specific country hub prices.[10]

It could be argued that the change from oil-linked to hub-price indexation should be made by making reference to the obtainable prices in the relevant gas market disregarding the actual prices obtained by the buyer and its market segmentation. If the indexation refers directly to the market, it could appear at first blush to be logical.

However, even if the contract sales price is the hub price, the market segmentation and the prices obtained by the buyer are still relevant. In fact, when the tribunal runs the market test, it should assume a contract sales price that would always entitle the buyer to obtain a reasonable margin on its own sales. To do so the tribunal should calculate the contract sales price based on the algebra calculations of the hub prices – in general the average monthly prices at the given hub of the month preceding the month of the day of the review date, adding or deducting the necessary value to the hub to arrive at the level that, at the review date, would allow the buyer to obtain a margin the tribunal deems appropriate.

The logic of revising the contact sales price following a request should not change depending on the nature of the request.

The main question is how the tribunal should determine the revised contract sales price. There are two possibilities.

The first is to determine a sort of ‘fixed’ price by taking the hub reference price and adjusting it, as the case may be, by adding or deducting a value expressed in the currency of the contract, and eliminating the P0 element of the contract sales price. The final result should be a contract sales price that would allow the buyer to sell the gas economically in the market taking into consideration its own market segmentation.

It could be argued that the end result would result in a major change in the structure of gas sales and purchase contracts as it would embed the principle of a potential guaranteed margin to the buyer. However, today this methodology is frequently used for sales of gas into end markets and it is also frequently used in the gas industry when seller and buyer agree to revise the contract sales price by changing indexation, or when they enter into a new sale and purchase contract. It could well be said that this is the new trend in the industry.

The second is to maintain the P0 element of the contract sales price and to change the indexation from oil to hub prices. However, in this case the tribunal should also change P0 to arrive at the intended result. In fact, the P0 element relates to the contract sales price level while the indexation formula relates to the movement of the contract sales price. Changing only the indexation formula to the hub prices would have the effect of locking the contract sales price to the market prices but would not necessarily enable the seller to obtain the margin it deserves under the contract. This would be the same as pretending that hedging the oil indexation formula basket products would be the solution to every price revision and to the fluctuation between contract sales prices and market prices. Obviously, this is not the case, as, in the gas industry, hedging the oil products of the indexation formula is far from being the right solution.

This second methodology relates to the scenario where the parties or the tribunal decide only to partly change the indexation formula from oil-linked products to the hub prices. It is very obvious that in such case there is still the need for a P0 element.

In general, it can be said that for tribunals to decide if and how to change the indexation formula incorporating hub prices into the contract sales price is a very difficult task that could hardly be achieved without the full cooperation of the parties and their experts, who would play a role of paramount importance. The tribunal should also consider appointing its own expert.

In conclusion, the process to review a contract sales price by changing the indexation formula and eliminating the P0 element would not be much different from the process in place to review a P0 element only when oil-linked. With the change to hub-price indexation the contract price would automatically adjust to the price of the market, as such that it could be defined as an automatic adaptation clause.

The authority of the tribunal to change the indexation formula

In any gas price review proceeding, either party or both parties may request the switch from an oil-linked to a hub-price indexation formula, unless it is expressly prohibited by the contract. If the contract generally provides for the right of either party to request a review of the contract sales price, it can be assumed that the tribunal may change or eliminate the P0 and change the indexation formula. In fact the contract sales price is always the end result of the price review, and what really matters is the final result. Therefore the tribunal may review the contract sales price at it wishes to do. In practice, some contracts, however, expressly limit the review to the P0 element, in which case the authority of the tribunal would be limited.

In the Atlantic LNG case the tribunal went even further. It decided to change the indexation formula even though neither party had requested it. This approach has given rise to doubts that the award was ultra petita.[11]

The other elements to take into consideration to determine the existence and extent of the tribunal’s authority to change the indexation formula are the governing law of the contract, the procedural legislation of the place of arbitration and the terms of reference agreed by the parties.

The effects of changing indexation formula on the contracts

As discussed above, changing the indexation formula of the contract sales price by the agreement of the parties or by the tribunal will have the same result as changing the P0 element, in either case the applicable contract sales price has been reviewed.

Although changing the indexation formula rather than P0 would apparently not change the end result, the consequences on the gas sales and purchase contract will be very different.

In first place, the risk allocation widely recognised in the industry[12] whereby the buyer assumes the volume risk through take-or-pay provisions and the seller assumes the price risk through the indexation formula would be dismantled, as would the parties’ right to periodically review the contract sales price.

With the oil-linked formula the seller takes periodically the risk of the P0 element as an essential part of the contract sales price, every time that a request of price review is submitted by either party (in general every three years). In other words the seller takes the risk of the decoupling between the contract sales price and the market price as the buyer must be able to sell the gas economically. With the change of indexation to hub prices and the elimination of the P0 element, the result is that the risk of the spread between the contract sales price and the market prices is taken on average every month, and not periodically. The price risk may then change its nature and become a ‘market risk’.

Some may assume that also the volume risk taken by the buyer should be amended to reflect the increased risks taken by the seller with the hub prices indexation.

In the new era of long-term gas sales and purchase contracts such change involves a deletion of the buyer’s contract flexibility through an increase up to 100 per cent of the level of take-or-pay and the consequent exclusions of make-up rights.

The effect of such change would, however, result in a change of the very nature of such contracts, from take or pay to take and pay.

Second, the switch to a full indexation to hub prices would also have the effect of dismantling the price review clause. The definition and interpretation of the buyer’s market and of the market value would no longer have any meaning. It would not be necessary to determine the market value as it would be that of the hub prices. The delta of delta methodology would become useless.

One interesting issue would be if the market margins at the wholesalers would change during the review period. Assuming that the new formula is the hub price minus a certain value, if that value has diverged from the market value, the question is if a price review could be requested to change such deduction from the hub prices to align the contract sales price to market value, namely if the possibility of the buyer to economically market the gas would be assessed against the general trend of the other market players.


A new era for gas long-term sales and purchase contracts has begun. The system created in the 1960s to trade gas long term with take-or-pay contracts is changing. The driving force of this change is the switch from oil-linked prices to hub prices. Inevitably, the existing format of gas long-term sales and purchase contracts is being profoundly reconsidered by the industry.

Are the ‘old’ contracts outdated? This seems to be the most fascinating question arising out of a decade of gas price reviews in continental Europe, which put enormous pressure on the oil-linked price formulae. This period has seen no less than three waves of price reviews, many of which have been resolved by arbitrations. If in the first wave (2010–2012), it was not an impossible exercise for the buyers to demonstrate decoupling between oil and market prices and their consequent incapability to sell the gas economically. With the second wave (2012-2015) the parties began to consider the resolution of the difficulties originating with the decoupling differently. With the final wave of price reviews begun in 2015, it has become obvious that the most efficient way to restore the equilibrium of the contract without requiring periodically the intervention of the tribunals was to eliminate the oil-linked formulae and to replace them with a system incorporating an automatic adaptation of the contract sales price to the market prices.

The reasons justifying the replacement of oil-linked formulae with hub-price indexation are found in the liberalisation and the increased liquidity of the markets that created several trading hubs in continental Europe. There is no need of referring to the gas to gas competition any more.

However, this is not new for the United States and the United Kingdom, where this system has been in place for a long time. As has been noted: ‘[t]he 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’.[13]

Increasingly the new generation of long-term gas contracts resemble the short-term and spot contracts as regards contract sales price and flexibility. Indeed, these ‘new’ long-term contracts have a new structure to reflect a change in the risk allocation, whereby the contract sales price is fully indexed to hub prices and along with such changes the flexibility granted in the ‘old’ system tends to disappear with volume clauses referring to 100 per cent of the agreed quantity of gas to be taken and the make-up rights no longer available to the buyers. Price review clauses are becoming meaningless, and with that the relevance of the principles of ‘market of the buyer’ and ‘economically market the gas’.

One could wonder if the next contractual provision to be affected by the changes contemplated with the switch from oil-linked to hub-price formulae will relate to the duration of the contracts, and with that the industry’s need for long-term contracts themselves. It is safe to assume that for the construction of new pipelines long-term contracts may be necessary to assure the return on the investment but, maybe, this will be the last change in the industry if the fears of Europe’s national governments and the European Union related to the security of supply will permit such change and align the conditions on which gas is imported to those in place in the United States and in the United Kingdom.

The future of price review clauses and of their application is becoming doubtful. The end result produced by this new trend would be the change in the nature of the gas sales and purchase contracts from a take or pay to a take and pay basis with all consequences arising therefrom.


[1]    Marco Lorefice ‘Crossroads in Gas Price Review Abitrations, J William Rowley (ed), The Guide to Energy Arbitration, (Global Arbitration Review 2015) at pages 161-172.

[2]    Ibid at page 161.

[3]    For example, in Italy, Eni Spa has stated that as of the end of 2015 approximately 70 per cent of its portfolio (22.46 Bcm) is hub-linked, ‘Eni, Relazione Finanziaria Semestrale Consolidata al 30 giugno 2016’, at page 51.

[4]    According to the Italian Regulator, the AEEGSI, about 50 per cent of the gas imported in Italy on a long-term basis (over five years) was hub-indexed in 2015 ‘Relazione Annuale sullo Stato dei Servizi e sull’Attività Svolta’, of 31 March 2016, at page 126.

[5]    The gas to be imported into Italy from Azerbaijan through the Tap pipeline has been negotiated on hub prices, see Il sole 24 ore, ‘Gas azero a prezzi sganciati dal petrolio’, 11 April 2014.

[6]    Lorefice at 167.

[7]    The implications of these two steps have already been discussed by the author in the previous edition of this publication.

[8]    M Leijten and M deVries Lentsch, Gas Price Arbitrations – A Practical Handbook, 2014; edited by M Levy, Published by Global Law and Business-Global Business Publishing Ltd, at page 42.

[9]    Where TTF is for each month of delivery the arithmetic average of the Heren Price expressed in €/MWh, for all days of the relevant month. Each day, the Heren Price shall be the mean average of the bid and offer prices under the title ‘TTF Price Assessment’, as published in the ICIS Heren European Spot Gas Markets of the closest previous London business day, for the following trading products: ‘day ahead’, if the concerned day is a London business day; ‘weekend’, if the concerned day is not a London business day. D is the x.y euro/MWh converted monthly from euros to dollars.

[10]   For example the Punto di scambio virtuale (PSV) in Italy.

[11]   Gas Natural Aprovisionamientos, SDG, S.A. v. Atlantic LNG Company of Trinidad and Tobago in the United States District Court for the Southern District of NewYork (2008) WL 4344525 (S.D.N.Y.).

[12]   Ana Stanic╦ś and Graham Weale, Changes in the European Gas Market and Price Review Arbitrations, page 325, Journal of Energy and Natural Resources Law, Vol. 25, No. 3 (2007); International Energy Law and Policy Research Paper Series Working Research Paper Series No. 2010/03, Centre for Energy, Petroleum & Mineral Law & Policy, University of Dundee (24 February 2010); A J Melling, Natural Gas Pricing and its future: Europe as the battleground, Carnegie Endowment for International Peace, 2010; Morten Frisch, Current European Gas Pricing Problems: Solutions Based on Price Review and Price Re-Opener Provisions, page 17, International Energy Law and Policy Research Paper Series Working Research Paper Series No. 2010/03, Centre for Energy, Petroleum & Mineral Law & Policy, University of Dundee (24 February 2010); Jonathan Stern, Continental European Long-Term Gas Contracts: is a transition away from oil product-linked pricing inevitable and imminent?, page 16, Oxford Institute for Energy Studies (September 2009).

[13]   B Holland and P Spencer Ashley, ‘Natural Gas Price Reviews: Past, Present and Future’, Journal of Energy & Natural Resources Law, Vol. 30, No.1, 2012, page 42.

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