Gas Price Review Disputes: Key Insights for a Successful Resolution

Much of the world’s pipeline gas and liquefied natural gas (LNG) is traded on hubs and therefore bought and sold as a spot commodity. However, long-term contracted supply remains important and contracts may have a duration of 20 years or more. The rationale for long-term supply for sellers, who are often (but not always) producers, is the benefit of committed offtake to set against their fixed capital costs of supplying the gas, while buyers seek security of supply and a varied portfolio of sources to ensure that domestic energy demands are met. The classic risk allocation in a long-term gas supply agreement (GSA) involves the seller assuming the ‘price risk’, committing to sell certain volumes at a set price for a certain period, while the buyer takes the ‘volume risk’, committing to offtake certain volumes, or pay for them, in any event (‘take or pay’). Thus a balance is struck and contractual equilibrium is achieved.

To set the price of gas supplied under a long-term GSA, parties historically pegged the price to competing fuel products, the logic being that the buyer required a price that would allow it to sell the gas in its home market where gas would be competing with other fuels, such as oil and coal. Given that there were established markets for oil and coal, these were used as proxies for the value of gas in the indexation element of the pricing formulas. However, contracting parties foresaw that, in the long term, such a contract price might fall out of line with the market and require adjustment to protect the buyer or the seller (or both) and maintain the agreed contractual equilibrium. The answer was the price review clause, which would allow periodic readjustment of the contract price, within the parameters agreed by the parties. Most such clauses provide for the parties to attempt to agree a negotiated solution, failing which there is generally a reference to international arbitration.

There are several distinctive aspects of gas pricing arbitrations that require specialist knowledge and handling. They are not typical, adversarial commercial arbitrations before tribunals that follow a claim for damages based on an alleged breach of contract or some other legal wrong. In gas pricing disputes there is generally no suggestion that a wrong has been committed. Instead, the parties are following the agreed process to vary one element of the contract – the price – to allow the contract to remain balanced for both parties for the long term.

The process is typically started by a party asserting that a trigger event has occurred. If the parties cannot agree on a price adjustment, an arbitral tribunal evaluates whether a trigger event has indeed occurred and, if so, it effectively steps into the shoes of the parties and adjusts the contract price on their behalf. The tribunal has a mandate, circumscribed by the precise terms of the price review clause and applicable law, to revise the contract price for the future. In so doing, it has to grapple with a number of complex (and often diverging) economic factors, including market changes, pricing metrics, transportation costs and the margins of the buyer and seller, while applying these factors in the context - and within the limits - of the relevant contractual provisions and applicable law. For that reason, the expert evidence presented by both sides is critical in almost all aspects of a price review: from the fundamentals of the parties’ original bargain to satisfying the required threshold factors and guiding the tribunal as to the appropriate level of price adjustment, and how this can be formulated in the contract.

This chapter addresses some of the main issues that arise in relation to gas pricing disputes and offers insights that can assist their successful resolution. It looks first at the anatomy of a price review clause, then at the negotiation phase that usually takes place once a review is requested, and finally at the arbitration that generally results if those negotiations are unsuccessful. It concludes with a few words about the outlook for gas price review disputes.

Price review clauses – typical features

The wording of a price review clause is critical, since it sets the ground rules for what follows. It invariably deals with such basic matters as the frequency of price reviews, what is required by way of notice, the documentation that must be provided, the length of negotiations between the parties, and the consequences of failing to reach an agreed solution. Although some GSAs provide for termination if a negotiated solution cannot be achieved, this is unusual. Typically a price review clause will provide for an expert or (more usually) an arbitral tribunal to rule on the matter. International arbitration has the benefit of privacy and confidentiality, which are important given the sensitivities around the commercial information at play in such cases. For that reason, very few details of past cases have emerged, except occasionally where challenges to awards have resulted in national courts revealing certain aspects.

Price review clauses come in different shapes and sizes. The precise language chosen has at the same time to be as precise as possible to avoid endless arguments between the parties as to how to interpret the provision, while being flexible enough to cater for the unpredictable future.

Price review clauses typically require the requesting party to show that certain qualitative changes have occurred that necessitate an adjustment to the contract price, namely a change of a certain significance, by the relevant time (the review date), beyond the requesting party’s control, which has affected the market value of gas in the reference market. In addition to the trigger event, a price review clause will frequently stipulate additional criteria to be factored in at the adjustment stage; for example, that the contract price must allow the buyer to economically market the gas or that the price under comparable contracts shall be used as a reference. All such terms and criteria inevitably become the source of debate between disputing parties. It is therefore important that a requesting party pays heed to the temporal and notice requirements and then to the various factors stipulated in the clause in question.

These factors are considered in more detail below.

Temporal limitations

Some GSAs entitle parties to seek a review at certain periodic dates (e.g., at three-year intervals),[2] while others allow an initial review at the mid-point of supply and then possibly again if the contract is extended. Occasionally, a GSA will allow parties to use a certain number of ‘joker’ (also known as ‘wildcard’) price reviews that can be requested for any reason and at any time (i.e., outside the prescribed price review windows). Whatever is provided in the GSA, it is incumbent on the requesting party to ensure that its request is brought within the prescribed time limits, otherwise the counterparty may argue that the review should not proceed. Tribunals may consider compliance with temporal conditions essential and reject a request that is made out of time.

Notice requirements

A price revision clause will typically require the requesting party to serve a contractual notice on the counterparty. It may also require it to propose a specific change to the price formula and to explain and substantiate the reasons for the requested adjustment. These particulars will, to a certain extent, determine the scope of the price review, should it go ahead, and they should therefore be drafted with care.

Compliance with notice requirements is important as it may constitute a condition precedent to the commencement of the price revision process. It also determines the date on which the price revision takes effect, also known as the price review date.

It is important for the requesting party to bear in mind that once it triggers a price review by issuing a valid notice, it may open up the process and thus the likelihood of receiving a formal claim from its counterparty. The question of whether the party receiving a notice must also serve its own notice has been debated and so it is generally advisable (even if not always strictly necessary) to err on the side of caution and for the receiving party to also serve notice of its own.

Another question that may arise in practice is whether it is open to a party requesting a price review to subsequently withdraw its request, by claiming ownership of the process as the party that initiated it. Advice on this point will turn on the wording of the review clause and the applicable law. In certain jurisdictions for example, the right to a price review constitutes a formative right, such that once exercised, the process is in principle irrevocable unless the parties both agree to terminate it. In these circumstances, the requesting party may lose the ability to discontinue the process unilaterally at a later stage.

Price review parameters

In addition to complying with any temporal and notice requirements, the requesting party must provide evidence of a certain level of change in the ‘reference market’.[3] Below are some of the factors that may be referenced in the relevant clause:

  • Change is outside the parties’ control or unforeseeable (or both): it is generally not possible for a party to rely on a change in circumstances that it has caused or contributed to. Certain clauses may also introduce an element of unforeseeability to prevent parties from relying on changes that were expected at the time of signing and already catered for in the contract price. However, even if a certain event is foreseen, it may not be possible to predict accurately how it will unfold and the effect that it may have on the value of gas sold in a specific market.
  • A significant or substantial change affecting gas prices: this is a common formulation and essentially requires the change to have a meaningful effect on the value of gas in the reference market. However, what constitutes a ‘significant’ or ‘substantial’ change is not a simple matter and requires expert evidence in support. To clarify the issue, some clauses require a requesting party to demonstrate a minimum divergence from the prevailing market price.[4]
  • Of a certain duration: some clauses require the change to have a certain duration or be of a structural nature. Consequently, temporary market shocks may not be relevant. In such cases, parties may seek to rely on other contractual provisions, such as those dealing with force majeure or hardship, which cater for extreme events in a different way.
  • Having occurred within the relevant reference period: the effect of the invoked market change must usually have been felt before the review date, and where a price review has already taken place, the new change must have occurred after the effective date of that price revision and before the date of the new request. If a particular event has occurred within the reference period but its effects have not yet been felt, the market change relied upon may not be deemed a sufficient basis for a price review.
  • Within the reference market: price review clauses require a change to have occurred in (or affected) the stipulated reference market. This will typically be the market of the buyer, although it may be a wider geographical region (such as western Europe). Although the clause may set certain parameters, ambiguities may still arise in practice. For example, the reference market may be defined as comprising a number of countries with diverse characteristics. The invoked change may therefore not be experienced to the same extent, or at the same pace, in all these countries. There may also be debate as to whether the change should be assessed by reference to the market as a whole or be limited to certain elements of it.

As well as demonstrating that a market change with the above characteristics has occurred, the requesting party must also establish that the proposed price adjustment is appropriate and in accordance with the terms of the GSA. To help parties (and the tribunal) calculate a new price, most GSAs set out criteria that the adjustment must fulfil. These may include the following:

  • Fair and equitable standard: most GSAs require a price revision to be fair and equitable. What that means in the context of a specific contract – especially one that has been in place for some time and has survived a number of market movements – can be difficult to ascertain. To assess what is ‘fair and equitable’ in any given situation, a tribunal might consider industry practice as well as all other circumstances, including the parties’ pre-contractual negotiations and conduct, as evidenced in witness testimony and contemporaneous documents.
  • Benchmarks and other comparators: some GSAs stipulate that the price adjustment should be made by reference to other prices as comparators, such as gas prices at hubs (e.g., National Balancing Point (NBP) in the United Kingdom, Title Transfer Facility (TTF) in the Netherlands), prices under comparable contracts or on the basis of the price level at the point of import. In such cases, issues may arise if the relevant data is not readily available because of the confidential nature of LNG and pipeline GSAs.
  • Economic marketing: certain clauses may require the revised contract price to be set at a level that allows the gas to be economically or competitively marketed in the buyer’s market, assuming the buyer engages in sound marketing practices and efficient operations. Whether this type of clause effectively guarantees the buyer a margin (and how that margin might be calculated) is a further source of debate.

Negotiation period

Following service of a price review notice, GSAs usually provide for a period of negotiation, during which the parties seek to agree a revised contract price.

While intended to facilitate the process, pre-arbitration steps may pose certain challenges. First, price revision clauses do not always stipulate the duration of negotiations or the precise steps that each party is expected to take. In other cases, it is not clear whether pre-arbitration negotiations are mandatory (i.e., whether they constitute a condition precedent to subsequent arbitration proceedings). It may be uncertain, therefore, what the implications are if, for instance, the requesting party fails to enter into negotiations or the counterparty wilfully obstructs discussions. Is the requesting party obliged to wait for the prescribed negotiation period to expire? Can it commence arbitration proceedings at an earlier date if negotiations appear to be futile? The answers to these questions will turn on the exact wording of the clause, the applicable law and the parties’ overall conduct. When the clause provides that negotiations must take place, a tribunal will exercise caution before assuming jurisdiction, for fear of exposing itself, or its award, to legal challenges down the line. Parties should thus generally err on the side of caution when a negotiation period is referred to in the contract in mandatory terms.

Within the confines of the relevant clause, parties are advised to seek sufficient early input from their chosen counsel and expert team to guide their negotiations in an attempt to arrive at a negotiated solution. Although on occasion there may be reason for a party to keep its powder dry, if for instance there is little chance of a successful negotiation, the best chance of a ‘win-win’ outcome will be a negotiated result, appropriately guided by counsel and experts. Such a solution remains in the hands of the parties who are best able to judge the equilibrium of their contract, the markets in which they operate, and what is therefore required by way of adjustment going forward. Therefore, it is recommended that parties give negotiation a proper chance and invest in the process, subject to safeguarding their position in case the matter does ultimately proceed to arbitration.

At the negotiation stage, parties can confer and share views and information on various questions, including the relevant trigger events and the appropriate price adjustment. The scope of these discussions will usually be guided by the price revision clause, but may also be determined by the parties on an ad hoc basis. Given the sensitive nature of the information being exchanged, it is important that the discussions are conducted without prejudice[5] and that an appropriate confidentiality agreement is in place (in the form of a confidentiality provision within the GSA or as a separate stand-alone agreement). This will prevent parties from seeking to rely on information exchanged during discussions in the course of any subsequent proceedings.

Dispute resolution

If negotiations prove unsuccessful, parties may resort to the contractually stipulated dispute resolution mechanism (usually international arbitration).[6] The matter will then be submitted to a tribunal, which will be tasked with determining whether a price adjustment is required and, if so, how the contract price or price formula should be revised.

Selecting the tribunal

To fulfil its role, the tribunal must assess a number of complex economic factors (market changes, pricing metrics, transportation costs and the parties’ margins) and apply these in the context of the particular contract and the particular governing law. The outcome of a gas pricing arbitration inevitably depends on the tribunal’s ability to grasp relevant legal principles and – potentially even more significantly – the economics of the case. In such cases, legal submissions and witness evidence often have a more limited role than the economic expert evidence.

It is essential, therefore, that the parties select properly qualified and sufficiently experienced tribunal members who are able to grapple with the evidence and answer industry-specific questions to determine whether the invoked change qualifies as a trigger event and, if so, what the appropriate price adjustment should be.

The role of the tribunal

As mentioned above, the tribunal’s role is not to address an alleged breach of contract but to step into the shoes of the parties and adjust the contract price or price formula if necessary. It will be guided by the relevant contractual provisions, the applicable law and all relevant factual circumstances. Its first task is to check that the requesting party has complied with all formal requirements, including any timing and notice conditions, and to establish that a trigger event has occurred. The tribunal then has to revise the contract price in such a way as to reflect the parties’ original bargain (and any prior res judicata decisions). In some cases, these steps will be separated and proceedings bifurcated, first to rule on the threshold issues and then, only if fulfilled, to move on to determine the substantive question of the necessary adjustment to the contract price.

Limits on the tribunal’s mandate

As with any commercial arbitration, the tribunal derives its jurisdiction from the parties’ arbitration agreement, which is usually embedded in the contract in the form of an arbitration clause. Therefore, the extent of the tribunal’s powers depends, to a large extent, on what is set out in the contract.

However, contracts vary considerably in the amount of detail they include regarding the tribunal’s powers and responsibilities. Some GSAs seek expressly to limit the tribunal’s power, for instance by stipulating that it be allowed to deal only with the revision of the contract price, and that other contractual provisions must not be affected. In this case, provisions regarding volume, flexibility, diversion rights, and others, cannot be altered.

Successive price reviews

Given the long duration of GSAs and the periodic nature of price revision clauses, parties may be repeat participants, finding themselves arguing about the same provisions of the same GSA before more than one arbitral tribunal at different times.

Special considerations arise in these situations, the most basic being the need for consistency with previously stated positions that have been accepted and adopted by earlier tribunals. Deviating from previous positions or determinations within prior awards may not be legally possible, since to do so risks contravening the principles of preclusion (or issue estoppel) and res judicata. The latter prevents parties (and tribunals) from relitigating issues, claims and defences that have already been heard and decided in previous awards.

The scope and effect of these principles differs from one jurisdiction to another. Tribunals will therefore need to have regard to the position under the applicable law[7] in order to determine what (if any) limitations may apply by virtue of prior submissions or awards (e.g., regarding issues of contractual interpretation).

In gas pricing disputes, the main challenge is usually to decide whether an issue being raised in later proceedings is in fact identical to the one that has previously been decided. Parties may argue that the factual and economic circumstances have shifted to such an extent that a previous determination on, for example, what constitutes an appropriate price benchmark, may no longer be relevant and so cannot be binding. However, decisions on certain issues (e.g., regarding contractual interpretation) are more likely to be considered binding for the life of the contract. So, for example, it would generally not be considered acceptable to argue that a contract provides for market-based pricing in one price review process, and then later to argue that the same contract provides for cost plus pricing. Buyers and sellers might be well advised, therefore, to take a long-term view of their contractual relations rather than being opportunistic and obtaining decisions that, while advantageous in the short term, could prove less so in the future.

Expert witnesses

Gas pricing disputes are by their nature expert evidence intensive, as they require extensive market and pricing analysis. It is usual, therefore, for parties to instruct specialist economic experts at the outset of the price review process. The requesting party will seek expert advice to establish that a trigger event has occurred and to help it present an appropriate, well-reasoned request for a price adjustment. The party receiving a request, in turn, will instruct an expert in most cases to examine the requested price revision, identify any weaknesses or ambiguities and assist generally in devising effective defences. If market fundamentals permit, the expert may also recommend that the receiving party makes its own request for an antithetical price revision.

If the matter is not resolved by negotiation, expert advice will inevitably feed into the parties’ submissions to the tribunal. Expert evidence is usually adduced to demonstrate what the contractual bargain entails, explain whether the trigger event has indeed occurred and whether a price adjustment is required and, if so, at what level. Experts will prepare their own independent reports, to be submitted alongside, and to guide, the parties’ submissions. As the review progresses, the experts will exchange views on particular issues (usually in the form of reply expert reports) and will ultimately be questioned orally at a hearing by counsel and the tribunal.

Witnesses of fact

In gas pricing disputes, factual witness evidence generally has a lesser role than expert evidence. Witness statements tend to be short accounts of pre-contractual negotiations, enabling a party to comment on the circumstances in which the GSA was concluded. Factual witness evidence may also be adduced to attest to market conditions, including competition in the reference market and sound marketing practices.

Future outlook

The above insights are the result of practical experience in advising both buyers and sellers of gas during the myriad gas price reviews that have taken place in Europe in the past 20 years. Global gas markets have undergone major changes during this time and liquid hubs are now well established, at least in Europe and the United States. The spate of gas price review arbitrations seen in Europe during this transition period of decoupling of oil and gas prices and continuing market liberalisation is likely to be coming to its natural conclusion. Indeed, some commentators have argued that the end of price review arbitration is nigh. In Europe at least, where contract prices are now widely referenced to hub prices (whether TTF or NBP), one would expect that further disputes should largely be avoided given that such contract prices now track the market.

Asia, however, is predicted to witness an increase in gas pricing disputes given that pricing remains largely oil-indexed, while Asian markets are gradually being liberalised and international participants are gaining market share. This is leading to wider reliance on gas price review clauses contemplating formal dispute resolution proceedings. This is welcomed by many Asian buyers, who are aware of the European experience and of the benefits that price reviews can bring. While disputes in Asia are indeed beginning to materialise, one could reasonably expect that fewer of them will ultimately be decided by arbitral tribunals as parties, their chosen counsel and expert teams can utilise the European experience to guide their negotiations and seek to recalibrate the contract price for the future.


Notes

[1] Devika Khanna is a partner at Clyde & Co LLP.

[2] For instance, the gas supply agreement [GSA] between Sonatrach and Distrigas stipulated that the parties will meet ‘every four (4) years’ while the Atlantic liquefied natural gas [LNG] contract allowed price revision requests on a triennial basis. The Sonatrach–Distrigas GSA (1976) is available at https://fossil.energy.gov/ng_regulation/sites/default/files/programs/gasregulation/authorizations/1988/applications/88_37_LNG1.pdf. The terms of the Atlantic LNG GSA are known because the award was challenged in the US courts. See Atlantic LNG Company of Trinidad & Tobago v. Gas Natural Aprovisionamientos SDG SA, UNCITRAL, Final Award dated 17 January 2008.

[3] A frequently cited example is the shift that the European gas market began to experience in 2008, moving from oil indexation to indexation of the price of gas quoted at markets or hubs. See Anthony J Melling, Natural Gas Pricing and its Future: Europe as the Battleground (2010), available at https://carnegieendowment.org/2010/10/12/natural-gas-pricing-and-its-future-europe-as-battleground-pub-41716.

[4] See Esso Petroleum & Production UK Limited v. Electricity Supply Board, in which the GSA provided that the contract price must deviate from the market price by a fixed percentage ([2004] EWHC 723 (Comm)).

[5] Whether or not ‘without prejudice’ privilege applies will depend on the applicable law.

[6] Some GSAs set out a two-tiered procedure, whereby parties first refer the issue to an expert, and then to arbitration. Others provide for expert determination alone.

[7] This is usually the law of the seat, since these are issues of procedure rather than substance.

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