Price crash may fuel contract renegotiation push
A prolonged era of sustained lower oil prices could result in widespread pressure to renegotiate contracts
While customers would certainly like to secure lower prices, whether they will be able to achieve them will depend on the balance of power in negotiations. While there is not a universally successful strategy, there are certain factors that can be applied in many situations to achieve sustained advantage, according to panellists at the PE Live 3 webinar.
“It very much depends on contract-by-contract, relationship-by-relationship and commercial factors,” says Wade Coriell, partner, international arbitration practice, at law firm King & Spalding. For example, in pricing for LNG cargoes “some will have very long-term relationships and be looking at things beyond an LNG SPA as well.”
The situation will also differ by regional and legal factors. “Whatever mechanisms there are under a contract to help force renegotiations will operate separately from commercial factors,” he says.
“There will be a mix of carrots and sticks—what kind of termination rights exist, the types of claims that can arise in the context of Covid-19 and whether they can be used as leverage. There have been reports that certain Chinese LNG buyers that have declared force majeure have done so with the hope of essentially using it as an entrée to renegotiate contracts.”
The ability to force a renegotiation will depend on the particularities of “clauses in contracts and the bite they have”, such as any price review provisions and whether price review disputes are subject to arbitration or expert determination. “All of this will come into play, so it is very case-specific,” adds Coriell.
Christopher Goncalves, managing director BRG energy & climate at consultants Berkeley Research Group, points out that there are multiple types of renegotiation. At one end of the spectrum are voluntary or informal negotiations where “the parties decide it is time to make changes in light of the market [conditions] and reach an agreement—but that is fairly unusual these days given the vast difference between buyers’ and sellers’ positions”.
Then there are formal renegotiations, under a structured price review provided for by the contract, and ultimately dispute provisions if an agreement cannot be reached.
“I think it is an objectively fair statement that over the last few years the initiative has been with the buyers because the markets are well supplied and prices have been under pressure,” says Goncalves. “That is more so now because of Covid-19 and recent developments in the market. But none of us know whether the current situation will be resolved quickly or there will be sustained structural impacts.”
Goncalves adds that price review provisions have the effect of smoothing out the more dramatic shifts in the market, creating a middle ground between buyers and sellers.
However, “sellers may see things very differently if and when the market hopefully rebounds,” says Richard Nelson, a partner in the energy practice at King & Spalding. “This is a cyclical game. What goes around, tends to come around. Over a long-term contract, there is always a quid pro quo to bear in mind, the long-term value of the relationship.”
The contractual price review option is designed to allow a party to revisit the price in the event that the underlying market price moves appreciably in relation to the contract price. “It is intended to be an objective standard, so it does not necessarily follow that if one party invokes a price review this year that the other party would do the same in three, four or five years down the line during the next price review window,” says Nelson. “It entirely depends on where the relevant market is at that time.”
While buyers want security of supply and sellers need stable demand, there are incentives for both to revise pricing if the market has moved in their favour, he says. “In some respects, it would be a significant oversight not to do that.”
If the parties are engaged in a broader commercial negotiation—outside the scope of a contractual price review—the result will just come down to the commercial leverage of the parties. “We have seen take or pay, for example, being used for commercial negotiating leverage, and we are probably on the tipping point of seeing force majeure being used for commercial renegotiation leverage,” says Nelson.